It's the old "good news, bad news" scenario when it comes to dealing with escalating interest rates. Investors have two choices and pros and cons come with both, according to

The choice is necessary again as investors have to determine if the latest rate hike is valid.

Even though rates tanked after the weak jobs report in May, they did rebound. The yield on the 10-year note has fought its way to over 4.10% after following below the crucial 4% level. Currently the movers and shakers in the bond market anticipate it will reach 4.26%--the average in 2004.

For those who are certain that rates are increasing, there is the option of either buying inverse mutual funds or short fixed income exchange traded funds.

Choices bring questions, however. While the inverse funds provide a good hedge, they carry large fees and offer little by way of transparency. The ETFs, while being less expensive and more transparent, bring their own issues.

Duration must be taken into account when gauging inverse bond returns. Juno's duration is 14, which suggests it should increase 10% to 15% when interest rates increase by a percentage point.

If a large turnaround is evident with yields escalating, then inverse funds offer flexibility and convenience for those seeking a hedge.

"You need clearance to short stocks, but with funds, you just put the money in," Anne Ruff, portfolio manager for the Juno fund told

The downside to inverse funds is the costs. The expense ratios of the ProFunds Rising Rate, Juno and Potomac Contrabond are high at 1.42%, 1.38% and 1.75% respectively.

Does the answer lie with ETFs, now numbering at more than 160? Just like investors they come in all shapes and sizes. Large-cap value and small-cap growth share the stage with funds from countries such as Singapore and Switzerland. The phenomenal growth aside, there are only half a dozen fixed-income ETFs. This is surprising given the heft of the $24 trillion bond market.

Barclays Global Investors offers the trio of ETFs that are tracking the U.S. Treasury market with each one following a different portion of the yield curve.

"The core feature of the fixed-income ETFs is the transparency of the costs and holdings," said J. Parsons, Barclays managing director. "You know what you own, so you can better decide whether it's the right product for you."

So it would seem that the ball is in the investor's court when it comes to selecting the option that works for them.


The staff of Money Management Executive ("MME") has prepared these capsule summaries based on reports published by the news sources to which they are attributed. Those news sources are not associated with MME, and have not prepared, sponsored, endorsed, or approved these summaries.



Subscribe Now

Access to premium content including in-depth coverage of mutual funds, hedge funds, 401(K)s, 529 plans, and more.

3-Week Free Trial

Insight and analysis into the management, marketing, operations and technology of the asset management industry.