Bringing you live news and features since 2006 

WisdomTree comments on using ETPs to hedge in turbulent times


Nizam Hamid (pictured), ETF Strategist at WisdomTree in Europe, has written a note on how to use ETPs to hedge fixed income portfolio risk in a turbulent Eurozone environment.
He writes that fixed income has been at the heart of European investor portfolios for many years with average allocations in 2016 standing at 51 per cent.

“Even in an environment of low or negative yielding domestic government bonds, overall allocations have remained high. Now Eurozone government bond investors are overwhelmingly focused on the risks relating to the end of quantitative easing and the potential for a rise in interest rates at some point in 2018.

“Markets have already had a sharp correction from the unparalleled instances of 10-year Bund yields hitting a low of -0.2 per cent in early July 2016. Since its peak in early August 2016, the Bloomberg Barclays Euro Aggregate Treasury Index has fallen by over 4.1 per cent. This contrasts with overall annualised returns of over 4.8 per cent that investors have enjoyed from 1998 to the end of 2016.

“The challenge now is how to hedge broad Eurozone fixed income portfolios against the possibilities of a more turbulent market environment. One of the main constraints for investors is often an inability to hedge using instruments such as futures, swaps or options. These can be complex to manage with respect to margin, total risk and exposure management. In this context, ETPs may be used to provide an operationally efficient and cost-effective hedge. As ETPs are listed and traded on exchange, investors may benefit from multiple liquidity providers, full transparency of pricing, TER and swap costs. Investors still need to be conversant with the technical aspects of short and leveraged ETPs such as daily rebalancing, compounding and the over-collateralised swap structure.”

To illustrate the benefits of hedging using ETPs, Hamid and his team have considered an underlying broad portfolio benchmark, the Bloomberg Barclays Euro Aggregate Treasury Index, and used WisdomTree’s Boost Bund 10Y 3x Short Daily ETP as the hedge. The period covered is when Bund yields moved into negative territory and then normalised, and is relevant to an environment where rising rates are likely to feature.

He writes that at a portfolio level, using a 3x Short ETP means that an investor only needs commit 25 per cent of the total portfolio value into the ETP to create a fully hedged position. This is due to the capital efficiency inherent in the -3x leveraged ETP, comparing favourably with other short ETPs that offer either -1x or -2x exposure.

“When initiated, the portfolio is 100 per cent hedged and by its very nature this hedge ratio is likely to evolve based on the performance of both the portfolio and the hedging instrument. To maintain an efficient hedge that can provide an appropriate level of portfolio protection it is usual to maintain the hedge ratio within certain conservative boundaries. In our example, we have chosen +/- 5 per cent as the threshold away from being 100 per cent hedged as it may be beneficial to rebalance the hedge ratio back in line to 100 per cent.”

In the context of a fixed income portfolio, with volatility as low as 4.3 per cent, Hamid comments that it is also possible that there may be relatively little need to rebalance.

“In our example, there are two rebalances over the four-month hedging period and the resulting hedged portfolio has annualised volatility of 1.3 per cent and overall returns -0.5 per cent compared to an unhedged portfolio that would have returned -3.3 per cent. In terms of other risk measures, an unhedged portfolio over the same period would have experienced a maximum drawdown of 4.5 per cent whilst the hedged portfolio was constrained to 1.2 per cent.

Hamid notes that it is also important to note the overall transaction costs for putting on, rebalancing and unwinding the hedge. As the underlying of WisdomTree’s Boost Bund 10Y 3x Short Daily ETP consists of front-month Euro-Bund futures, the spreads and transaction costs reflect those of the underlying. Based on historic data the total transaction costs for the hedge are estimated at less than 5bps, he writes.

In summary, Hamid writes that WisdomTree’s Boost short fixed income ETPs may represent an operationally and capital efficient means of protecting broad fixed income portfolios from upcoming macro and interest rate risks.

“Compared to other short ETPs with lower leverage, -3x or -5x can significantly lower total portfolio volatility. After a prolonged multi-year bull market in fixed income and with considerable risks ahead with the unwinding of quantitative easing by the ECB and the possibility of a gradual albeit modest rise in interest rates in 2018, investors may wish to contemplate hedging their fixed income exposures,” he concludes.

Latest News

Saving and investing app, Moneybox, has doubled the number of ETFs available on the platform, in the light of ‘growing..
Global X ETFs has announced the appointment of Ryan O'Connor as its Chief Executive Officer effective as of April 8, 2024. ..
Value-driven structured credit investing firm, Angel Oak Capital Advisors, LLC, has announced the completed conversions of two of its mutual..
Confidence in the continuing strength of bitcoin and Ethereum is driving wider interest in altcoins and other digital assets, according..

Related Articles

Sal Esposito, Zacks Investment Management
Zacks Investment Management started doing investment research in 1978 and in 1992 started its investment management arm, initially with SMAs...
Jeremy Senderowicz, Vedder Price
Jeremy Senderowicz, a member of the Investment Services Group at law firm Vedder Price, has witnessed a steady upswing in...
Graham MacKenzie, Toronto Stock Exchange
The evolution of ETFs has been a multi-decade experience for Toronto Stock Exchange says Graham MacKenzie, managing director, Exchange Traded...
Frank Koudelka, State Street Global Services
ETF data provider and ETF Express data partner, Trackinsight, has published its Global ETF Survey 2024 Report: ‘50+ Charts on...
Subscribe to the ETF Express newsletter

Subscribe for access to our weekly newsletter, newsletter archive, updates on the site and exclusive email content.

Marketing by