6 ETF Strategies to Hedge Rate Risk

MarketsETF Trends

This article was originally published on ETFTrends.com.

As investors anticipate rising interest rates ahead, investors may look to various ETF strategies that are designed for this kind of environment.

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The economic expansion is aging with many signs that are signaling potential monetary policy changes ahead.

"We've got this big fiscal stimulus called the tax cut - just like out of the textbooks, it is about eight or nine years too late. We really are seeing yields on Treasuries come up, inflation coming up, labor markets tight, central banks shrinking their balance sheets," Simeon Hyman, Head of Investment Strategy for ProShares, said at the Inside ETFs 2018 conference.

Nevertheless, investors with a traditional portfolio mix don't need to be too worried as there are now a number of ETF strategies designed to limit rising rate risks ahead.

For instance, Hyman pointed to inverse Treasury bond ETFs that capitalize on rising rates or falling bond prices. Inverse bond ETFs "give you the opportunity to create your own hedges, rotate the position when you think the rates are going to rise," Hyman said.

An ETF like the ProShares Short 20+ Year Treasury (NYSEArca: TBF) may provide a simple short or inverse exposure to long-term Treasuries. For more aggressive traders, the ProShares UltraShort 20+ Year Treasury (NYSEArca: TBT) tries to reflect the -2x or -200% daily performance of the Barclays U.S. 20+ Year Treasury Bond Index, and the ProShares UltraPro Short 20+ Year Treasury (NYSEArca: TTT) takes the -3x or -300% daily performance of the Barclays U.S. 20+ Year Treasury Bond Index.

Another option that has recently hit the market includes ETFs that specifically incorporate an interest-rate hedging factor in their indexing methodology to help investors generate the same yields they have become accustomed to without the negative price effects of rising rates.

For instance, the ProShares High Yield Interest Rate Hedged ETF (Cboe: HYHG) and ProShares Investment Grade-Interest Rate Hedged ETF (Cboe: IGHG) are two rate-hedged bond ETFs that achieve their diminished rate-risk status by shorting Treasury notes. The underlying portfolio shows a near-zero duration – duration is a measure of sensitivity to changes in interest rates, so a zero duration translates to no sensitivity to changes.

Additionally, Hyman highlighted the relatively new ProShares Equities for Rising Rates ETF (NasdaqGM: EQRR) as the first U.S. stock ETF designed to outperform traditional large-cap indices, like the S&P 500, during a rising rate environment. The ETF selects 50 components from a universe of the 500 largest companies based on market capitalization listed on the U.S. exchange that have historically outperformed during periods of rising interest rates. Over the past three months as yields on benchmark 10-year Treasury notes rose to 2.85% from 2.55%, EQRR increased 7.1%, compared to the S&P 500's 5.0% advance.

For more ETF-related commentary from Tom Lydon and other industry experts, visit our video category.

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