Rather than hide from the effects of rising interest rates, which cause bond prices to fall, daring investors can bet on a certain kind of investment to benefit as interest rates ratchet up.
The investment? Inverse-bond exchange-traded funds (ETFs).
How they work: Inverse-bond ETFs buy derivatives and futures contracts designed to produce the opposite daily return of major bond indexes. For example, if the Barclays US Treasury Index, a popular gauge of intermediate-term Treasury securities, drops by 1%, the corresponding inverse-bond ETF should rise by 1%. These ETFs are best used to hedge an existing investment in bonds, but they also can be used to profit from a bet on rising rates.
Timing is critical. The Federal Reserve recently indicated that it may start to scale back its massive bond-buying program later this year and end it altogether by mid-2014 if the economy continues to strengthen, causing interest rates to jump.
Caution: There are leveraged versions of these inverse-bond ETFs that are designed to rise much more than interest rates do. Example: The Direxion Daily 20+ Year Treasury Bear 3x ETF seeks to provide 300% of the inverse (opposite) performance of the NYSE 20 Year Plus Treasury Bond Index. Such funds are very risky. The Direxion ETF has gained as much as 28% in some three-month periods but lost nearly 60% in others.
Inverse-bond ETFS to consider now: ProShares Short 7-10 Year Treasury ETF (TBX)…ProShares Short 20+ Year Treasury ETF (TBF)…and ProShares Short Investment Grade Corporate Bond ETF (IGS).