Interest rates

Simplify ETF offers a way to hedge rising interest rates

It looks like the 40-year bond bull market is over. At the height of the COVID-19 pandemic, the 10-year US Treasury bond yield bottomed out at 0.51% in August 2020. Since then, the 10-year yield has been steadily rising as that the Federal Reserve is raising interest rates in an effort to combat a US inflation rate that is rising at its fastest pace in 40 years. On Wednesday April 20, the 10-year rose to 2.98%, its highest level since December 2018.

Bond prices move inversely to bond yields, so when yields were so low, bond prices were near their highs. As yields rise dramatically, prices fall. Holders of government bonds, corporate bonds and bond funds suffer significant losses.

As the Fed threatens to aggressively raise interest rates in an effort to combat rising inflation, there is huge risk of deeper declines in stock and bond portfolios. Investors wishing to hedge against these declines could take a look at an exchange-traded fund (ETF) launched a year ago, the Simplify Interest Rate Hedge ETF (PFIX), which seeks to provide a direct and transparent hedge against the rise interest rates. .

Key points to remember

  • Bond yields have risen steadily over the past two years, driving down bond prices.
  • The Federal Reserve is raising interest rates to fight soaring inflation and is threatening to raise rates more aggressively this year.
  • The Simplify ETF seeks to hedge rising interest rates using swap options.

Simplified Interest Rate Hedging ETF (PFIX)

  • Year-to-date performance: 47.9%
  • Expense ratio: 0.50%
  • Assets under management: $245.7 million
  • Creation date: May 5, 2021
  • Issuer: Simplify asset management

Since the start of the year, as the 10-year Treasury yield nearly doubled, the PFIX ETF has jumped 48%, according to Morningstar.

About 50% of the fund’s portfolio holds over-the-counter (OTC) interest rate options on swaps, called swaptions, and cash. These swaptions are generally only available to institutional investors. This gives the fund transparent convex exposure to large upward movements in interest rates and interest rate volatility. The rest of the portfolio, 56% at the end of February, holds US Treasury bonds.

The fund is designed to be “functionally similar” to holding long-term put options on the 20-year Treasury. “The initial investment of 50% of net asset value in a 7-year OTC payer swaption on the 20-year rate hit at 4.25% provides direct exposure to rising rates,” according to Simplify ETFs.

“It gives you price appreciation to offset the loss you would realize in a stock or bond portfolio as rates rise,” said Michael Green, chief strategist at Simplify Asset Management.

Hikes on the Horizon Rates

On Thursday, Fed Chairman Jerome Powell, speaking before a panel of the International Monetary Fund (IMF), said the central bank was determined to bring inflation down and was considering a bigger rate hike than usual next month.

“It’s appropriate in my opinion to go a little faster,” Powell said. “I would say 50 basis points will be on the table for the May meeting.”

The ETF closed Friday 2.5% higher than it was when markets opened Thursday. If, as Powell suggests, rates continue to rise, so should PFIX.