Market Pulse: Should you hedge your bond portfolio?
The Fed raised rates last week and is expected to do so again in the fall. Long-term rates might rise, too, if economic activity accelerates. Is it time to hedge your bond portfolio to limit your risk?
Many people think so. Some investors are hedging portfolios by owning the Direxion Daily 20-Year Treasury Bear 3X (TMV), a fund that attempts to deliver triple the daily inverse returns in treasuries, or the ProShares Short 20+ Year Treasury (TBF), which moves inverse to treasuries but without leverage. But buyer beware.
Leveraged and inverse funds serve a purpose for day traders, but are not good long-term investments. Just look at 2008. Suppose someone had the foresight to predict the fall in real estate values and bought ProShares UltraShort Real Estate (SRS).
If the investor bought SRS on Oct. 1, 2008, right before the financial collapse, and held it through the rest of that year, the investor would have been right but would have lost 30 percent. Another example, Chinese stocks lost half their value from mid-March 2008 through October 2008, but ProShares Ultra-Short China (FXP) lost nearly 20 percent of its value. So leverage cuts both ways.
Some bond exchanged-traded funds (ETFs) place hedges more efficiently by matching durations to their bond holdings. Two good examples are ProShares Investment Grade Interest Rate Hedged (IGHG) and ProShares High Yield Interest Rate Hedged (HYHG).
I’m not hedging my fixed-income portfolio. I’ve avoided treasuries and short-term investment-grade corporates because their low yields make them vulnerable to rising rates. Rates would have to go much higher, however, to make high-yielding bonds and non-real estate investment trust (REIT) preferreds unattractive. I don’t expect that.
For a few years it was widely assumed that interest rates will head higher. When everyone is on one side of a trade count on a move in the opposite direction. I don’t expect much higher rates (see my March 16 article) and hold no hedges in my portfolio. Still, for those who want to protect their portfolio from rising rates, there are some good ETF choices.
David Vomund is an Incline Village-based, fee-only money manager. Information is found at http://www.VomundInvestments.com or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.