Profit from Rising Interest Rates with ETFs

By: Money_and_Markets

Ron Rowland  writes: Have you looked at interest rates lately? They’re soaring! Back on March 18, the 10-year Treasury bond yield dropped as low as 2.54 percent. This week it went above 3.90 — a huge move in less than three months. The same thing is happening in all but the very shortest maturities.

The reason isn’t hard to figure out: Between bank bailouts, stimulus packages, and old-fashioned waste, our government is spending money faster than the IRS can collect it.

Massive borrowing by the federal government is driving up rates for everyone. Mortgage rates are pointing up, too, which won’t help the housing market recover any sooner.

Fortunately, a select group of ETFs and mutual funds are designed to turn this trend in your favor. These “inverse bond funds” actually gain in value as interest rates go up! Today I’ll tell you where to find these funds and how to use them most effectively.

The Bond Market See-Saw …

First, I want to make sure you understand something important: Bond yields and bond values always move in opposite directions. Think about it like a playground see-saw. If one side goes up, the other has to go down.

So when you read that bonds are up, it is another way of saying that bond yields are down. Likewise, if you hear that bond yields are rising, you know the value of bonds is falling.

Bond prices always fall as interest rates rise.

Rising interest rates are bad news if you own bonds because they drive down the present value of your holdings. Yes, you should still get your scheduled payments of principal and interest, but you may have missed an opportunity to make even more.

This is not a new problem, of course. Traders have always speculated on bond prices, and institutions that lend and borrow money often use the futures market to hedge their interest-rate exposure. However, the average individual investor was left out in the cold.

That is until 1995, when the Rydex mutual fund family introduced the first inverse bond fund. Originally called Rydex Juno, the name was later changed to Rydex Inverse Government Long Bond Strategy (RYJUX). RYJUX was designed to deliver the inverse price performance of the current long-term Treasury bond.

RYJUX is still available today. But now you have other options, too.

• ProFunds Rising Rates Opportunity (RRPIX) is very similar to RYJUX but adds a 1.25X leverage factor.
• ProFunds Rising Rates Opportunity 10 (RTPIX) moves opposite from the ten-year Treasury bond, without leverage.
• If you are really aggressive, the Direxion 10 Year Note Bear 2.5X (DXKSX) is an inverse ten-year bond fund with 2.5X leverage.

Treasury bonds aren’t the only interest-rate game in town, of course. If you watch the high-yield “junk” bond market and think it is due for a fall, you can pick from three unleveraged inverse mutual funds:

• Direxion High-Yield Bear (PHBRX)
• ProFunds Access Flex Bear High Yield (AFBIX)
• Rydex Inverse High Yield Strategy (RYIHX)

What About ETFs?

All of the funds I’ve named above are traditional mutual funds. That means they have the disadvantages I told you about in my Money and Markets column, Why ETFs Beat Mutual Funds By A Mile. For instance, you can only trade once a day and the fees tend to be high.

The good news is that now you can get inverse exposure to Treasury bonds with ETFs, too! In fact, you have four different choices:

• ProShares UltraShort 20+ Year Treasury (TBT)
• ProShares UltraShort 7-10 Year Treasury (PST)
• Direxion Daily 10-Year Treasury Bear 3X (TYO)
• Direxion Daily 30-Year Treasury Bear 3X (TMV)

All of these ETFs are leveraged: The two ProShares offerings have 2X daily leverage, while the Direxion ETFs have 3X daily leverage.

Notice this term: “Daily leverage.” It’s very important to understand that leveraged ETFs (inverse or otherwise) re-set their leverage factor every day. That means you can’t depend on getting 2X or 3X performance for periods longer than one day. It might be more or it might be less, depending what the markets do.

If you’re right about the direction of interest rates, the payoff from leveraged ETFs can be huge.

Actually, I regard all leveraged ETFs as trading vehicles, not long-term investments. They’re a really useful tool if you have a strong indication about the market’s short-term direction.

If you’re right, you may be able to amplify your gains. If you’re wrong, you can lose your shirt very quickly. So be sure to use these ETFs with caution — and if they start to move against you, get out pronto!

Another caution with all the inverse funds, leveraged or not: Don’t count on getting any interest payments while you own these funds.

In fact, since you are effectively in a short position, you’re paying a dividend to someone else! Not a pleasant thought. But the ultimate payoff can be huge if you’re right about the interest rate trend!

Best wishes,

Ron

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