After a three-decade bond market rally, fixed income investors have grown complacent with their U.S. Treasury holdings. With interest rates expected to rise, it may be time to consider alternative income exchange traded fund strategies to better manage the potential risks ahead.
The 10-year Treasury yield is supposed to reflect what investors believe the return on money at the risk-free overnight rate set by the Federal Reserve will be, adjusted for a “term premium,” or some leeway built into the yield as insurance against rate bets going wrong, Justin Lahart writes for the Wall Street Journal. However, current yields reflect the market’s view that the main risk to forecasts is that they could be too high.
Specifically, when 10-year notes were at 1.56% on December 23, the 10-year overnight rate was 1.86% after adjusting for an estimate of the term premium. In comparison, Fed policymakers project the midpoint range on the overnight federal-fund rate will rise to 0.75% by the end of 2022, to 1.625% by the end of 2023, to 2.125% by the end of 2024, and average out to 2.5% over the longer run. If the forecasts hold true, the current 10-year yield is over half a point too low, and that’s not considering the current inflation risks, which can contribute to even higher levels of overnight rates than forecasted.
In comparison, back in 2011, the 10-year yield was 1.9%, and after adjusting for the term premium, Fed funds had an implied return of 1.05% annually for the next decade. However, the actual return was 0.63%.
In other words, the 10-year Treasury was a much better investment than risk-free short-term assets would have been in the past few decades.
Looking ahead, after years of enjoying falling rates, complacent fixed income investors may no longer find that Treasuries can provide a similar position in a diversified bond portfolio.
Consequently, investors should reconsider their holdings and rebalance positions to best fit their investment horizon and fixed income needs. For instance, ETF investors may look to something like the Nationwide Nasdaq-100 Risk-Managed Income ETF (NYSE Arca: NUSI) to seek current income with a measure of downside protection.
NUSI follows a rules-based options trading strategy that seeks to produce high income using the Nasdaq-100 Index, an index of the 100 largest non-financial stocks on the Nasdaq exchange. The ETF may potentially complement traditional equity and fixed income allocations or function as a possible hedge for investors.
The Nationwide Risk-Managed Income ETF establishes a collar strategy to generate monthly income. Collar strategies involve holding shares of the underlying stock while at the same time buying protective put options and writing calls for the same security. A put option gives its owner the right but not the obligation to sell the underlying asset at a specified price and on a specified date. A call option gives its owner the right but not the obligation to buy that asset instead.
For more news, information, and strategy, visit our Retirement Income Channel.
This article was prepared as part of Nationwide’s paid sponsorship of ETF Trends.
ETFs, hedge funds, equities, bonds, and other asset classes have different risk profiles, which should be considered when investing. All investments contain risk and may lose value. Investing involves risk, including the possible loss of principal. Shares of any ETF are bought and sold at market price (not NAV), may trade at a discount or premium to NAV and are not individually redeemed from the Fund. Brokerage commissions will reduce returns. The Fund’s return may not match or achieve a high degree of correlation with the return of the underlying index.
The NUSI Prospectus may be accessed at: https://nationwidefunds.onlineprospectus.net/nationwidefunds/NUSI/index.html
Call 1-800-617-0004 to request a summary prospectus and/or a prospectus. You may also download the prospectus at the link above or by visiting etf.nationwide.com. These prospectuses outline investment objectives, risks, fees, charges and expenses, and other information that you should read and consider carefully before investing.
The results shown represent past performance; past performance does not guarantee future results. Current performance may be lower or higher than the past performance shown, which does not guarantee future results. Share price, principal value, and return will vary, and you may have a gain or a loss when you sell your shares. To obtain the most recent month-end performance, go to etf.nationwide.com or call 800-617-0004.
Click this link for the funds’ Standardized performance and 30-day SEC yield.
KEY RISKS: The Fund is subject to the risks of investing in equity securities, including tracking stock (a class of common stock that “tracks” the performance of a unit or division within a larger company). A tracking stock’s value may decline even if the larger company’s stock increases in value. The Fund is subject to the risks of investing in foreign securities (currency fluctuations, political risks, differences in accounting and limited availability of information, all of which are magnified in emerging markets). The Fund may invest in more-aggressive investments such as derivatives (which create investment leverage and illiquidity and are highly volatile). The Fund employs a collared options strategy (using call and put options is speculative and can lead to losses because of adverse movements in the price or value of the reference asset). The success of the Fund’s investment strategy may depend on the effectiveness of the subadviser’s quantitative tools for screening securities and on data provided by third parties.
The Fund expects to invest a portion of its assets to replicate the holdings of an index. Correlation between Fund performance and index performance may be affected by Fund expenses and because the Fund may not be invested fully in the securities of the index or may hold securities not included in the index. The Fund frequently may buy and sell portfolio securities and other assets to rebalance its exposure to various market sectors. Higher portfolio turnover may result in higher levels of transaction costs paid by the Fund and greater tax liabilities for shareholders. The Fund may concentrate on specific sectors or industries, subjecting it to greater volatility than that of other ETFs. The Fund may hold large positions in a small number of securities, and an increase or decrease in the value of such securities may have a disproportionate impact on the Fund’s value and total return. Although the Fund intends to invest in a variety of securities and instruments, the Fund will be considered nondiversified. Additional Fund risk includes: Collared options strategy risk, correlation risk, derivatives risk, foreign investment risk, and industry concentration risk.
Nasdaq-100 Index: An unmanaged, market capitalization-weighted index of equity securities issued by 100 of the largest non-financial companies, with certain rules capping the influence of the largest components. It is based on exchange, and it is not an index of U.S.-based companies. Market index performance is provided by a third-party source Nationwide Funds Group deems to be reliable (Morningstar). Indexes are unmanaged and have been provided for comparison purposes only. No fees or expenses have been reflected. Individuals cannot invest directly in an index.
Nationwide Fund Advisors (NFA) is the registered investment advisor to Nationwide ETFs, which are distributed by Quasar Distributors LLC. NFA is not affiliated with any distributor, subadviser, or index provider contracted by NFA for the Nationwide ETFs.
Nationwide, the Nationwide N and Eagle and Nationwide is on your side are service marks of Nationwide Mutual Insurance Company. © 2022 Nationwide.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.