Simplify ETF Offers Way to Hedge Rising Interest Rates

It looks like the 40-year bull market in bonds is over. At the height of the COVID-19 pandemic, the yield on the U.S. 10-year Treasury bond bottomed out at 0.51% in August 2020. Since then, the 10-year’s yield has been steadily rising as the Federal Reserve raises interest rates in an effort to combat a U.S. inflation rate surging at its fastest pace in 40 years. On Wednesday, April 20, the 10-year hit 2.98%, its highest point 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 tumble. Holders of government bonds, corporate bonds, and bond funds are experiencing significant losses.

With the Fed threatening to aggressively raise interest rates in an effort to combat the growing inflation, there is tremendous risk of more significant declines in both equity and bond portfolios. Investors wanting to hedge against these declines might want to 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 rising interest rates.

Simplify Interest Rate Hedge ETF (PFIX)

• Performance Year-to-Date: 47.9%
• Expense Ratio: 0.50%
• Assets Under Management: $245.7 million
• Inception Date: May 5, 2021
• Issuer: Simplify Asset Management

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

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

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

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

Rates Hikes on the Horizon

On Thursday, Fed Chair Jerome Powell speaking on an International Monetary Fund (IMF) panel said the central bank was determined to bring inflation lower and was considering a larger-than-usual rate hike next month.

“It is appropriate in my view to be moving a little more quickly,” said Powell. “I would say 50 basis points will be on the table for the May meeting.”

The ETF closed on Friday up 2.5% from where it was when markets opened on Thursday. If, as Powell suggests, rates continue to go higher, PFIX should as well.