Negative Duration Bond ETFs: Right Time To Bet?

market bondsWith increasing energy prices, growing inflationary expectations and an improving job market, the Treasury yields have been on the rise yet again in recent weeks. Yields on 10-year Treasury notes saw a sudden and sharp jump from $1.890 on April 16 to near $2.35 as of today – the highest level in more than five years.

The most recent surge in yields came from solid April job numbers. The government report showed that the U.S. economy added 223,000 jobs in April, suggesting a strong rebound from the revised 85,000 job gains reported in March – the worst monthly performance in almost three years. This has spread optimism and confidence into the U.S. economy, easing fears of an extended slowdown. The unemployment rate dropped to 5.4%, the lowest level since mid 2008. Robust job numbers also raised speculation that a rate hike by the Fed is back on the table.

Further, new debt sales from both the U.S. government and the private sector scheduled this week triggered a sell-off in bond markets, pushing yields higher. Moreover, the Fed last week stated that “bond yields could see a sharp jump when it raises its benchmark interest rate for the first time since 2006.”

Given this, yields will continue to move up, hurting the returns of investors who have big holdings in the fixed income world. If this happens, bond investors might experience heavy losses given that bond prices and yields have an inverse relationship. With the inclusion of some negative duration bond ETFs, this hostile situation can be avoided. Investors could add these products in their portfolio to minimize the risk from rising interest rates.

Why Negative Duration Bond ETFs?

These funds cushion against rising rates through an inverse exposure to Treasuries and increase value when rates rise.

Negative duration bond ETFs offer exposure to traditional bonds while at the same time short Treasury bonds using derivatives such as interest-rate swaps, interest-rate options and Treasury futures. The short position will diminish the fund’s actual long duration, resulting in a negative duration. As a result, these bonds could act as a powerful hedge and a money enhancer in a rising rate environment.

Currently, there are two negative duration bond ETFs available on the market that investors could play for rising rates with lower levels of risk. Both are from one issuer – WisdomTree.

WisdomTree Barclays U.S. Aggregate Bond Negative Duration Fund (NASDAQ:AGND)

This ETF tracks the Barclays Rate Hedged U.S. Aggregate Bond Index, Negative Five Duration. The benchmark provides long positions in the Barclays US Aggregate Bond Index, which consists of Treasuries, government bonds, corporate bonds, mortgage-backed pass-through securities, commercial MBS & ABS, while short positions in U.S. Treasuries corresponding to duration exceeding the long portfolio, with duration of approximately negative 5 years.

About 64% of the portfolio is focused on investment grade or AAA rated bonds. The fund has amassed $27.2 million in its asset base while trades in a paltry volume of under 9,000 shares. Expense ratio came in at 28 bps. The product has gained 2.1% over the past for weeks.

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