How NOT to Hedge a Long-Term Rise in Interest Rates

  • SumoMe

The fear of rising interest rates is one of the biggest concerns among many investors at the moment.  And in light of the fact that interest rates declined for roughly 30+ years and have essentially been moving sideways for roughly 5 years these fears may not be unfounded. But what to do about the prospect for a longer-term rise in rates is an entirely different question.

(See also Post-Election April and May)

People who are expecting higher interest rates in the years ahead may be inclined to think that buying an inverse bond fund might protect them. But the short answer is this:

*Inverse bond funds are for trading purposes only, NOT for buy-and-hold.

Let me put it another way just to be clear:

1) If bond yields rise sharply over a relatively short period of time an inverse bond fund can rise sharply (and in so doing does in fact serve its purpose as a hedge against higher interest rates).

2) If bond yields rise slowly, inverse bond funds will likely lose value over time – albeit with the occasional sharp rally every once in awhile if and when the pace of the rise in yield happens to pick  up.

3) If bond yields drift sideways – especially over a longer period of time, inverse bond funds will lose a great deal of value in the process (more on this scenario in a moment).

4) If bond yield move lower over any meaningful period of time, inverse bond funds will lose a surprisingly large amount of value.

The Dangers of Inverse Bonds Funds

Figure 1 displays the 30-year treasury yield in the top clip and ticker TBF (ProShares Short 20+ Year Treasury ETF) in the bottom clip. 1Figure 1 – 30-Year Treasury Yields vs. Inverse Long-Term Treasury Bond ETF (Courtesy AIQ TradingExpert)

Note that while the yield on 30-year treasuries has essentially traded sideways since September 2011, ticker TBF has continued to lose significant ground.  Since 9/30/11:

*30-year treasury yields have moved from 2.92% to 2.86%

*Ticker TBF has moved from $32.15 to $22.77 (-29.2%)

The bottom line:

*If your timing is excellent and you buy just before a meaningful rise in rates inverse bond funds can make money.

*If rates decline or even simply move sideways, inverse bond funds will lose (likely a significant amount of money).

If you are looking to hedge against a long-term rise in interest rate – look elsewhere.

You have been warned.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

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