Investors with exposure to traditional Treasuries will take a beating if bond prices begin to dip off their three-decade long run and yields start to rise. Nevertheless, there are exchange traded fund options to help cope with the shifting tides.
Jason Schenker, president of Prestige Economics, argues that the market faces "an impending rise in interest rates" as the economy grows and inflation rises, reports Trang Ho for Investor's Business Daily. Schenker suggests investors should switch out of fixed-income assets and into equities, commodities and housing to protect against rising rates. [Bond ETFs: What Happens When the Fed Goes Home?]
Of course, that doesn't mean investors should cash out of bonds completely. Fixed-income investments can provide income, diversification and safety in volatile stock markets.
For every bond, duration reveals the security's sensitivity to interest rate risk. Typically, a one year duration roughly translates to a 1% change in the bond's price for each percentage change in yields, IBD notes. Consequently, bond ETFs with a longer duration have more to lose in a rising rate environment.
For instance, the iShares Barclays 7-10 Year Treasury ETF (IEF) has corrected 3$ from its 52-week high of 109.89 on July 25 as yields on the ETF rose to 1.77% from 1.43%. The iShares Barclays 20+ Year Treasury ETF (TLT) dropped 11.4% from its 52-week high from July 25 as yields increased to 2.54% from 2.11%.
Todd Rosenbluth, director of ETF research at S&P Capital IQ, in the IBD article also warned that high-yield and investment grade corporate debt may also get hit due to emotional selling and liquidation.
Instead, Rosenbluth suggested looking into the SPDR Barclays Capital Short-Term High Yield Bond ETF (SJNK) as it has a lower duration. SJNK has a 2.12 year duration and a 4.54% 30-day SEC yield. In comparison, the SPDR Barclays High Yield Bond ETF (JNK) has a 4.32 year duration and a 5.21% 30-day SEC yield. [Short-Term Bond ETFs for Rising Rates]
For the more aggressive approach, investors can look at the ProShares 20+ Year Treasury ETF (TBF), which produces the inverse daily performance of long-term Treasuries. The fund has gained 9.4% from July. Since it the fund rebalances daily, the ETF's performance may not perfectly reflect the long-term inverse performance of the underlying index over a long period of time.
Timothy Evans, chief market strategist at Long Leaf Trading Group, also suggests the PowerShares DB U.S. Dollar Index Bullish Fund (UUP).
"When interest rates start to rise, the dollar usually gains momentum against other currencies because higher rates attract foreign capital to investment instruments that are denominated in dollars, such as T-bills, notes and bonds," Evans said in the article. "Money chases yield and an influx in capital will be U.S. dollar friendly."
Max Chen contributed to this article.