ETF Expert Corner

Bryce Doty Spotlights Sit Rising Rate ETF, Talks Fed

October 4th, 2016 by ETF Store Staff

Bryce Doty, Senior Portfolio Manager at Sit Investment Associates, spotlights the Sit Rising Rate ETF (RISE) and offers some thoughts on the current interest rate environment.


You can listen to our interview with Bryce Doty by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: The ETF we're spotlighting this week is the Sit Rising Rate ETF, ticker symbol RISE. We're very pleased to welcome back to the program Bryce Doty, Senior Portfolio Manager at Sit Investment Associates. Bryce oversees some $7 billion in fixed income investments and Bryce is now joining us via phone from Minneapolis. Bryce, great to have you back on the show.

Bryce Doty: Thanks for having me back.

Nate Geraci: Bryce, let’s just jump right in here. This ETF offers investors a way to profit from rising interest rates. Tell us how this ETF works.

Bryce Doty: RISE has a negative 10 year duration, which means it's looking to make about a 10% profit or appreciation in price for a 1% increase in bond yields. So it can have a significant effect on your portfolio even if you only have a small portion of RISE in your portfolio. As far as how it works, we're shorting treasury futures and options on futures. We're primarily focusing on the 2 and 5 year part of the curve. We also have a small put position on the 10 year treasury position, but the reason we're focusing the most on the 2 and 5 year part of the curve is because that is where we expect yields to move the most when the Fed raises rates and that's certainly been the case last December when they first raised rates.

Nate Geraci: Bryce, when we talk about shorting futures contracts, and you mentioned put options, I know these can sound somewhat complex to some investors, can you maybe explain what these are and how they work?

Bryce Doty: It's a process that was created in the financial markets to make money when prices of securities are going down. When bond prices are going down, RISE should be going up. The way it works is, I just think of it as borrowing something from your neighbor and saying I'll get this back to you in 3 months. In the meantime, you've taken that and you've sold it to someone. So let’s say it's a bond and you sold it to someone else at $100 hoping that over the course of the next 3 months, rates will go up, bond prices go down, you're able to buy that bond back at $95 to return to your neighbor and you keep that $5 profit that you made in the interim. So you actually are making money and other bonds are losing money.

Nate Geraci: At the website for this ETF, which is, you offer a wonderful tool. It's called the RISE calculator and this allows investors to calculate the impact of interest rate increases on their bond portfolios and it shows how RISE could help hedge that impact. Can you walk us through a basic example of how this might work?

Bryce Doty: If you have, let’s say a 4 year duration portfolio and rates go up 2%, your bonds will lose 8%, certainly not the kind of thing that a typical bond investor is prepared for. This calculator shows the impact that can happen for different interest rate scenarios. There's only 3 inputs into it, we're trying to make it fairly easy to use. On the top line you put in the yield of whatever your existing bond portfolio is, let’s say its 4% and then you put in the duration of your bond portfolio, and again just for simplicity let’s say that's also 4, 4 years of duration. Then you can see what would happen if you added RISE to that portfolio. If you took a portion of your bond portfolio and put it into RISE or any instrument with a negative 10 year duration. I would recommend just putting in 15% for now and then if you click on the calculate button, it'll show that the yield declines because RISE you should think of as insurance, and all insurance costs money. The yield will drop about a percent, from let’s say 4 to 3%, but your interest rate risk, your duration, will be cut in half, form 4 to actually less than 2 years. We see this as a more attractive alternative to selling out of a bond portfolio. You may have to pay capital gains and what not, give up all of your yield, and going into cash or a short duration fund. The give up in yield would be much more dramatic and since we don't really know when exactly the Fed is going to do what they're going to do, we like this as a better alternative to cash or a short duration fund.

Nate Geraci: We're visiting with Bryce Doty, Senior Portfolio Manager at Sit Investment Associates. They manage the Sit Rising Rate ETF, again the ticker symbol on that is R-I-S-E, RISE. Bryce, obviously the Fed has only raised interest rates once in the past decade, they certainly continue to threaten rate hikes but they haven't actually followed through, and obviously without rising rates this ETF is going to have a difficult time appreciating in value. Two questions here. One, is there a cost to this ETF if rates stay flat, just due to the cost of the futures and the put options, and then two, when is the right time to think about owning an ETF like this?

Bryce Doty: The Fed has been constantly faking out the market, just the discussion that they've had about a raise in rates has created a lot of volatility and caused yields to bounce around all over the place and so we like to think of RISE as providing a shock absorber against that volatility. When you talk about cost, again I think of RISE as insurance, if you just have that insurance and nothing else in your portfolio but RISE, and rates don't do anything. The cost would be about 3% a year which is why you don't want to have to use a lot of it. Even just a 10% allocation to a bond portfolio could provide a lot of protection and again, a 10% allocation would only be a .3% cost to the overall bond portfolio. As far as timing goes, it's like collision insurance, you know when's a good time to buy that? Well before the accident occurs. So you want to have that in place, before let’s say this Friday's employment report, or before the December Fed meeting. It's always a good time to have some element of insurance in your portfolio.

Nate Geraci: Bryce I'm curious, how does this ETF compare to some of the inverse bond ETFs that are out there?

Bryce Doty: Those, they rebalance daily which creates a lot of transaction costs. RISE targets rebalances to an exact negative 10 year duration once a month, so that saves on money and transaction costs. It also has a lower overall cost. A lot of the ones that are out there, if rates don't move at all it may cost you 5 to as high as 8% a year, so those are some of the key issues. The last one is that this fund is designed specifically for a Fed rate increase because it's so heavily focused on the 2 and 5 year maturities that tend to move the most in yield when the Fed does act.

Nate Geraci: Bryce as it relates to the Fed, what are your thoughts on how they've handled monetary policy over the last few years? Do you think they've gotten it right?

Bryce Doty: No. The short answer is no. It's helped to have rates come down and be low, they've gone so far now that it's incentivized a lot of leverage in some of the riskier areas of the market, which I do not think is a healthy thing for the country. The explosion of their balance sheet by creating $4 trillion out of thin air to invest in the financial markets has artificially propped up financial markets. So here we are with a situation where you have a pretty solid economy, full employment, inflation has risen to right around their 2% target rate, but financial markets have become increasingly risky, increasingly volatile because it's a little bit of a house of cards. They've been propped up artificially by central banks, primarily our own, so I think that has done us a disservice, and so that part of Fed policy I'm definitely not in agreement with.

Nate Geraci: Again we're visiting with Bryce Doty, Senior Portfolio Manager at Sit Investment Associates. Bryce, obviously you believe having some insurance against rising rates in a portfolio makes sense for most investors, but putting that aside, how do you think investors should be approaching bonds right now, just in general? What's the right balance between risk and reward in a bond portfolio? Should investors be quote on quote "chasing yield" in areas like junk bonds and emerging market debt and longer duration treasuries, what's the right balance here?

Bryce Doty: That's a great point. It used to be where it was worth it to take extra risk in high yield MLPs, you know REITs, and you mentioned emerging markets. It used to be a good trade to take extra risk and get extra return, really maximize the return without necessarily worrying as much about the downside. I think that's really changed in the last year. I think now you benefit from reducing your income potential and perhaps invest in things that provide some protection. Maybe you look at a longer duration municipal bond strategy that has fairly high qualities, investment grade, the default rate on municipal bonds is lower than corporate bonds, but you do have some interest rate risk with being out on the yield curve and having more duration. Blending something like that with RISE could give you a decent amount of tax-free income, a fair amount of protection against a rise in rates, without taking on the excessive risk of let’s say a bank loan. ETF or an MLP fund. I think that's the balance that people need to strike now versus a year ago when it was kind of, you could be a little more aggressive.

Nate Geraci: All right Bryce, we have a few minutes left here and we certainly don't advocate making market calls on this show, nobody has a crystal ball but ... I'm just curious as you look forward, obviously we have the presidential election upcoming here, the Fed is meeting in early November before election day and then they meet again in December. I'm just curious, as you kind of chart out what you expect to see moving forward from interest rates, can you give us sort of the base case?

Bryce Doty: Well we have seen six round trips in interest rates so far this year, where they've gone up and come right back down and that type of volatility is likely to persist because of the things you named. There's so much uncertainty surrounding each of the items, around the Fed, around the election, and Brexit, there's a whole host of other issues out there that I think that the yield curve will flatten, the long end will probably come down a little bit in yield but the short end is going to go up a fair amount as we get closer and closer to the end of the year. I don't think the Fed is going to raise rates in November because it's so close to the election, but in December I think it might look a lot like last year in December when they raised rates. Certainly the economy is doing better, there'll be less uncertainty around the election and inflation is certainly higher than it was a year ago. So I'm looking for December as being a prime time that they may raise rates.

Conor Kelly: Bryce, this is Conor Kelly. Could you explain to our listeners first what a flat yield curve is and any potential implications if we do have a flattening yield curve later this year?

Bryce Doty: Flattening means that the longer maturity treasury yields are coming down more than ... becoming closer in yield to short term yields. So a 2 year treasury is yielding about .8, 30 year treasuries are 2.4, that's a gap of 1.6%. We think that gap will narrow, so maybe the difference between a 2 year treasury and a 30 year treasury yield might only be 1.2 or 1.4 over the next 6 to 9 months. Now the implications are that the shorter end of the yield curve may do poorly with yields rising there and prices going down, which is one reason we've structured RISE the way it is because that's a great protection from that event. Whereas at the longer end, I'm not as concerned about price decline because the longer end of the treasury curve reacts the most to inflation and inflation has risen some, but if the Fed does act that would provide a relief for investors and longer maturities that are afraid the Fed has taken their eye off the ball.

Nate Geraci: Well Bryce, with that we're going to have to leave it there. Very interesting ETF, we certainly appreciate you joining us on the program again. Thank you very much for your time today.

Bryce Doty: Thank you.

Nate Geraci: That was Bryce Doty, Senior Portfolio Manager at Sit Investment Associates. Again the ETF is the Sit Rising Rate ETF, ticker symbol R-I-S-E, RISE, which is a great ticker symbol by the way. You can learn more about this ETF by visiting