Protection from rising rates - hedged bond etf?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
boglerdude
Posts: 911
Joined: Fri Jul 10, 2015 1:28 am

Protection from rising rates - hedged bond etf?

Post by boglerdude »

We have an illiquid rental property so for now we're overweight inflation protection.

A 70s style grind to 5%+ on the 10 year would smash stocks, long bonds, gold, and real estate.

Looking at short duration bond funds. Why not take some credit risk? Cash and long treasury allocation covers credit risk.

Global short term junk https://www.morningstar.com/etfs/arcx/pghy/quote

Interest rate hedged junk https://www.morningstar.com/etfs/bats/hyhg/quote

Interest rate hedged corporate https://www.morningstar.com/etfs/arcx/lqdh/quote

How do the rate hedged funds work? No free lunches right

What are you using in your portfolio for rising rate insurance/protection? Any stocks/sectors that would do well?
Last edited by boglerdude on Mon Sep 21, 2020 10:23 pm, edited 1 time in total.
000
Posts: 4952
Joined: Thu Jul 23, 2020 12:04 am

Re: Protection from rising rates - hedged bond etf?

Post by 000 »

I think these would work like floating rate bonds. There are actual float funds you can check out for comparison: FLOT and FLTR. Of course, like most everything else they dropped during the March 2020 liquidity crisis.

Some people think bank stocks will do well if rates rise.

Right now I am just holding on to cash which will retain nominal value during liquidity crises and also get reinvested at higher rates if rates rise.
Always passive
Posts: 914
Joined: Fri Apr 14, 2017 4:25 am
Location: Israel

Re: Protection from rising rates - hedged bond etf?

Post by Always passive »

Help me understand why you want protection from rising interest rates now? If there is one place where you will get an honest answer is at the FED, and they have said repeatedly that they are not going to rise interest rates for a few years, in fact they may control the entire yield curve, not only short term yields. The only way you may see rates going up if by miracle and suddenly inflation takes off way above the FED's target of 2% and the FED needs to act. How can that happen in the middle of the present unemployment mess. Now, if inflation is your concern, get a short term inflation protected fund. Vanguard's VTIP will be an excellent choice.
Robot Monster
Posts: 2523
Joined: Sun May 05, 2019 11:23 am
Location: New York

Re: Protection from rising rates - hedged bond etf?

Post by Robot Monster »

boglerdude wrote: Mon Sep 21, 2020 9:55 pm Why not take some credit risk?
Global short term junk https://www.morningstar.com/etfs/arcx/pghy/quote
BlackRock agrees.
We stay overweight high yield as a source of income despite recent underperformance. We avoid energy as lower oil prices challenge the ability of issuers to refinance near-term maturities.
Source
"I think we may see a return to full employment next year." -- Janet Yellen, March 23rd 2021
Topic Author
boglerdude
Posts: 911
Joined: Fri Jul 10, 2015 1:28 am

Re: Protection from rising rates - hedged bond etf?

Post by boglerdude »

Looks like real rates peaked at ~7.7% in ~1984
https://www.longtermtrends.net/real-interest-rate/

There are a couple "rising rate" ETFs that sound like gimmicks
https://etfdailynews.com/news/this-risi ... t-is-fdrr/

I'm leaning toward the Global Short Term High Yield Bond ETF
https://www.invesco.com/us/financial-pr ... icker=PGHY
Robot Monster
Posts: 2523
Joined: Sun May 05, 2019 11:23 am
Location: New York

Re: Protection from rising rates - hedged bond etf?

Post by Robot Monster »

boglerdude wrote: Mon Sep 21, 2020 9:55 pm A 70s style grind to 5%+ on the 10 year would smash stocks, long bonds, gold, and real estate.
Did gold and real estate really get smashed in the 70's?

Gold
From Jan 1972 - Dec 1979, gold had an inflation adjusted CAGR of 25.87%. link

Real Estate
From 1970-1979, average compounded real returns (US$):

Global market portfolio-----1.65%
Equities broad---------------0.33%
Real estate----------------5.10%
Nongovernment bonds-----2.04%
Government bonds broad--1.72%
Commodities----------------22.02%
Source

Which was embedded in the paper, Historical Returns of the Market Portfolio
"I think we may see a return to full employment next year." -- Janet Yellen, March 23rd 2021
Blue456
Posts: 1383
Joined: Tue Jun 04, 2019 5:46 am

Re: Protection from rising rates - hedged bond etf?

Post by Blue456 »

:sharebeer
boglerdude wrote: Mon Sep 21, 2020 9:55 pm A 70s style grind to 5%+ on the 10 year would smash stocks, long bonds, gold, and real estate.
Raising interest rates is like working out in a gym. No pain no game man!

I would love the interest rates to go up to 5%. I would get 40% haircut on my bonds but down the road the bonds would yield more and more than make up for it. And since I am still in accumulation phase I would be buying some cheap bonds on sale.

You should be more afraid of inflation of 5% and interest rates of 0%.
Robot Monster
Posts: 2523
Joined: Sun May 05, 2019 11:23 am
Location: New York

Re: Protection from rising rates - hedged bond etf?

Post by Robot Monster »

Blue456 wrote: Tue Oct 06, 2020 8:34 am You should be more afraid of inflation of 5% and interest rates of 0%.
I don't know about 5%, but I do have two sources that suggested it would be a good idea if the Fed raised its target to as far as 4%. It's the reason why I choose to invest in TIPS, rather than cash. There is simply no guarantee Fed will not change target.

"Raising the long-term inflation target from the current 2% to a still-modest 4% would substantially increase the rate at which debt effectively vanishes." link

"One alternative to the Fed’s current approach would be to keep targeting the inflation rate, but to raise the target from the current 2 percent, perhaps to 3 percent or 4 percent." link

You may wonder, can the Fed really do this? Isn't their 2 percent target engraved in stone? It is not. "In 1996, Fed policymakers privately agreed that their target for inflation was 2 percent, but, at Greenspan’s insistence, they didn’t tell anyone. In 2012, at the urging of then-Chair Ben Bernanke, the Fed formally and publicly announced that they were targeting a 2 percent inflation rate." (same source as prior link)
"I think we may see a return to full employment next year." -- Janet Yellen, March 23rd 2021
JackoC
Posts: 2332
Joined: Sun Aug 12, 2018 11:14 am

Re: Protection from rising rates - hedged bond etf?

Post by JackoC »

Always passive wrote: Tue Sep 22, 2020 12:22 am18
Help me understand why you want protection from rising interest rates now? If there is one place where you will get an honest answer is at the FED, and they have said repeatedly that they are not going to rise interest rates for a few years, in fact they may control the entire yield curve, not only short term yields. The only way you may see rates going up if by miracle and suddenly inflation takes off way above the FED's target of 2% and the FED needs to act.
But by the other side of the coin of 'no free lunch', it's relatively inexpensive now to hedge against rates rising, in term of the negative carry of being short treasuries (practically speaking for retail investors, being short treasury note futures). At this time in 2009 the short term rate was near zero, but the 7 yr yield (the cheapest to deliver issues into the most liquid 10 yr note futures contract ticker ZN are usually closer to 7yr than 10 yr) 2.85%. Now it's zero v 0.55%. To answer OP's question about how it works basically you'd expect to pay out that yield and receive the (zero-ish) implied repo rate in return if rates don't change. That will trim a good deal of return off your fixed rate risky bond fund, but again not nearly as expensive as 2009 when the market was much less sure short term rates would remain near zero for a long time (but they did, and being short treasuries for a long time was a very expensive hedge, since 7yr yields only ever got to around 3.10% by 2018, with big negative carry on the hedge for years). Because, the market perception now is generally in line with your summary.

*If* one finds credit risky bonds attractive though, and worries about rate risk, rate hedging a low cost high yield fund like VWEAX (SEC yield 4.02%) could make sense. But hedging obviously doesn't make sense if you're convinced rates will stay very low for a long time. Nor do credit risky bonds necessarily make sense if you're convinced stocks are a better place to take what's related though not identical risk, the common view on this forum. Anyway there are hedged bond funds which will do this for you, or use risky floating rate notes rather than fixed rate bonds, but the extra ER is typically a lot for something relatively simple to DIY.

Buying 'riskless' bonds and hedging the rate risk almost never makes sense. And I don't think investment grade corporate bond funds are attractive rate hedged or not. Vang's medium term inv corp fund VFIDX SEC yield 1.53% duration 5.8 and you're short at least some issuer call options. You can match that rate with an extremely good 5 yr CD which is practically as credit 'riskless' as treasury and where you are also long a put option (early withdrawal with penalty) if rates spike (so less reason to rate hedge). Whereas inv grade corps have real credit risk especially at the lower threshold of BBB*. With US corporate junk (or other risky bonds like emerging market) you're actually getting something to take more risk, though as a risk preference issue you can decide it's not enough. With inv grade corps you're not really getting anything compared to highest FDIC insured rates.

*significant cost over time not so much for bonds going bust when held by the fund, but getting downgraded to junk and dumped from the fund at a loss.
chem
Posts: 94
Joined: Sun Apr 12, 2020 7:45 am

Re: Protection from rising rates - hedged bond etf?

Post by chem »

Here's how corporate bond ETFs performed for ~2 years starting in late 2016. Red curve is the change of ten-year treasury bond yield. Dark blue is LQD, green is LQDH (open image in new window for hi-res version).

Image

The iShares interest-rate hedged bond ETFs, (LQDH and HYGH) seem like a way to get good risk-adjusted return when rates may rise. LQD gave you nothing over that two-year period, but its hedged version gave you 9%.

links:
https://www.ishares.com/us/products/264 ... e-bond-etf
https://www.ishares.com/us/products/264 ... d-bond-etf

Very much interested in LQDH for my corp bond asset allocation in the 2021-2023 range.
Always passive
Posts: 914
Joined: Fri Apr 14, 2017 4:25 am
Location: Israel

Re: Protection from rising rates - hedged bond etf?

Post by Always passive »

chem wrote: Tue Oct 06, 2020 11:00 am Here's how corporate bond ETFs performed for ~2 years starting in late 2016. Red curve is the change of ten-year treasury bond yield. Dark blue is LQD, green is LQDH (open image in new window for hi-res version).

Image

The iShares interest-rate hedged bond ETFs, (LQDH and HYGH) seem like a way to get good risk-adjusted return when rates may rise. LQD gave you nothing over that two-year period, but its hedged version gave you 9%.

links:
https://www.ishares.com/us/products/264 ... e-bond-etf
https://www.ishares.com/us/products/264 ... d-bond-etf

Very much interested in LQDH for my corp bond asset allocation in the 2021-2023 range.

Interesting. I was not aware of these hedging ETFs
User avatar
HomerJ
Posts: 16743
Joined: Fri Jun 06, 2008 12:50 pm

Re: Protection from rising rates - hedged bond etf?

Post by HomerJ »

boglerdude wrote: Mon Sep 21, 2020 9:55 pmA 70s style grind to 5%+ on the 10 year would smash stocks, long bonds, gold, and real estate.
Rising rates do not destroy bond funds. Inflation is the real danger, and inflation is what caused the problem in the 70s.

Bond funds self-correct.

If interest rates rise, yes, bond fund values go down, but rates are rising, so they slowly pay out more as they pick up new bonds with the higher rates.

Shorter-term bond funds will recover faster.
A Goldman Sachs associate provided a variety of detailed explanations, but then offered a caveat, “If I’m being dead-### honest, though, nobody knows what’s really going on.”
Always passive
Posts: 914
Joined: Fri Apr 14, 2017 4:25 am
Location: Israel

Re: Protection from rising rates - hedged bond etf?

Post by Always passive »

HomerJ wrote: Tue Oct 06, 2020 12:11 pm
boglerdude wrote: Mon Sep 21, 2020 9:55 pmA 70s style grind to 5%+ on the 10 year would smash stocks, long bonds, gold, and real estate.
Rising rates do not destroy bond funds. Inflation is the real danger, and inflation is what caused the problem in the 70s.

Bond funds self-correct.

If interest rates rise, yes, bond fund values go down, but rates are rising, so they slowly pay out more as they pick up new bonds with the higher rates.

Shorter-term bond funds will recover faster.
Most recommend short term Tips, like VTIP
chem
Posts: 94
Joined: Sun Apr 12, 2020 7:45 am

Re: Protection from rising rates - hedged bond etf?

Post by chem »

A main purpose of an interest-rate hedged bond ETF is that it effectively removes the duration risk and the ETF acts more like a short-term ETF (in response to treasury yield volatility), but with exposure to long-dated credit.
Topic Author
boglerdude
Posts: 911
Joined: Fri Jul 10, 2015 1:28 am

Re: Protection from rising rates - hedged bond etf?

Post by boglerdude »

so with LQDH i pay out the ~7 year rate (to match the fund duration) and i get paid the repo (very short term rate)

Now if rates change the value of my bond fund does not change because it has duration zero. so for example the 7 year goes from .5 to 3%, my fund doesnt take a hit but now im paying out 3% of my dividend

But OTOH the dividends from the bonds in the fund will rise?

So the risks of the fund are bonds defaulting or being called, or people dumping corporates in a panic like March?

Aside from that, it would be safe to move in and out of this fund with no concerns about where rates are going? (unlike a long term bond fund where if rates spike you have to wait to make up the loss with the increased coupons).

I'm not particularly interested in corp bonds, just some hedge against 80s style rates pulling down asset values.

Here's another discussion: viewtopic.php?t=168038
chem
Posts: 94
Joined: Sun Apr 12, 2020 7:45 am

Re: Protection from rising rates - hedged bond etf?

Post by chem »

boglerdude wrote: Fri Oct 16, 2020 12:07 am so with LQDH i pay out the ~7 year rate (to match the fund duration) and i get paid the repo (very short term rate)

Now if rates change the value of my bond fund does not change because it has duration zero. so for example the 7 year goes from .5 to 3%, my fund doesnt take a hit but now im paying out 3% of my dividend

But OTOH the dividends from the bonds in the fund will rise?

So the risks of the fund are bonds defaulting or being called, or people dumping corporates in a panic like March?

Aside from that, it would be safe to move in and out of this fund with no concerns about where rates are going? (unlike a long term bond fund where if rates spike you have to wait to make up the loss with the increased coupons).

I'm not particularly interested in corp bonds, just some hedge against 80s style rates pulling down asset values.

Here's another discussion: viewtopic.php?t=168038
if you're worried about treasury yields going up a lot, LQDH seems to be effective as at least a partial hedge in the corp bond world.
https://stockcharts.com/freecharts/perf ... X,LQD,LQDH

adjust the period of the above-linked chart to 150 days or so (double click on the slider). You can see that as T-bond yields have risen since the march market crash, LQDH has slightly outperformed LQD in total return while also being less volatile. There is similar performance for other past periods of rising rates. Really interesting financial instrument.
Post Reply