Tahoe Market Pulse: Should you hedge your bond portfolio?
November 17, 2016
Interest rates were creeping higher before the election, but the Trump victory pushed the yield on the 10-year Treasury above 2.2 percent. The thought is that a President Trump will increase spending on infrastructure and the military. More spending combined with lower taxes means the Treasury will borrow more. Banking stocks have welcomed the higher rates. Not so for bond funds. Vanguard's Total Bond Index Fund (BND) lost 2 percent last week. Is it time to hedge your bond portfolio?
Some people think so. Money is moving into ProShares Short 20+ Year Treasury (TBF), which moves in the opposite direction as Treasury prices. This fund rose 7.5 percent last week. But buyer beware. Inverse funds (especially ones with leverage) serve a purpose for day traders, but are not good long-term investments.
Some bond ETFs do the hedging for you and do so more efficiently by matching durations to their bond holdings. Two good examples are ProShares Investment Grade Interest Rate Hedged (IGHG), which yields 3.2 percent, and ProShares High Yield Interest Rate Hedged (HYHG), which yields 5.6 percent.
Maybe a more profitable hedge is to own the SPDR Bank ETF (KBE). Banks often rally when rates rise so this security could move inversely to bonds. KBE yields 1.5 percent and has an expense ratio of 0.35 percent.
I'm not hedging my fixed-income portfolios. I've avoided Treasuries because their low yields make them very vulnerable to rising rates. Rates would have to go much higher, however, to make high-yielding bonds and non-REIT preferreds unattractive. Plus, some of the preferreds are near their par value so the threat of a call will act as support.
Wall Street is piling on the higher interest rate trade. As is often the case, they'll take it too far. The economy certainly has room to grow, but how optimistic can one be if the global economy is flat or if trade tensions emerge? I don't see rates rising far, but for those who want to protect their portfolio from rising rates, some ETFs can help.
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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 adviser before purchasing any security.
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