These ETFs hedge against rising interest rates and volatility. Here’s how risky it is to invest
Protection plays are in vogue as stocks extend their winning streak.
Investors have been seeking hedges against everything from inflation to rising interest rates to unprecedented volatility all year, funneling around $5 billion in the past 12 months into exchange-traded funds using options to enhance or protect their returns.
With the Federal Reserve looking to taper its bond purchases at the end of 2021, two of Simplify’s newest launches could come in handy, the firm’s co-founder and CEO Paul Kim told CNBC’s “ETF Edge” on Monday.
The Simplify Interest Rate Hedge ETF (PFIX) buys put options on longer-term Treasury bonds to offer what Kim called “the most liquid and the most cost-efficient way of getting interest rate protection.”
It’s “essentially a concentrated call on yields,” he said. “It’s saying over the next seven years, if something makes interest rates go up, this strategy is positioned to do well and protect an overall portfolio.”
Simplify’s Volatility Premium ETF (SVOL) takes a slightly more complex approach to drawing income out of swings in the Cboe Volatility Index.
“How do you deliver yield or return or income in a very low-yield environment? Certainly, fixed income is struggling. Equities have low dividend yields now and are priced to perfection. One of the most attractive premia, in our views, that has yet to be tapped broadly is the volatility premium,” Kim said.
As investors begin to build in portfolio protection using options, “it’s creating a very steep VIX curve, and what this strategy does is collect the difference between two parts of that curve,” which has the potential to deliver 20-25% in carry, or profit from the difference, he said.
Though major spikes in the VIX could hurt SVOL, “if the VIX spike is steep enough, it could actually turn into a net gain in the overall strategy,” Kim added. “It’s sort of trying to clip a carry, a coupon, off a very attractive curve, but while playing some defense through the use of limits through options.”
Numerous money managers have deemed such strategies worth the risk, said ETF Trends’ Dave Nadig.
“We’ve seen a [rash] of these types of products that extract income from unlikely places because, frankly, there’s nowhere else to get income,” Nadig said.
“With the bond market the way it is right now, nobody really wants to get 1.5 on the 10-year,” currently yielding just below 1.3%, he said. “It’s just not attractive. Advisors are looking for any sorts of additional income they can, particularly for their older clients who are in retirement.”
Though nothing will ever be as low risk as buying Treasurys and holding them until they mature, PFIX and SVOL offer strategies that may at least run shy of the risk that comes with buying equities, Nadig said.
“How risky is it? Well, it depends a little bit on what the equity markets do,” he said. “The good news here is if the equity markets are frothy and volatile, it will do what it’s supposed to do and generate a lot of income for you.”
