PFIX - PFIX: Rate-Hedged ETF A Buy Following The Yield Plunge

2023-03-17 06:57:12 ET

Summary

• PFIX was a top-performing bond ETF in 2022 as interest rates increased.
• With the latest drop in rates, investors have a chance to re-enter PFIX at favorable relative levels.
• With interest rate volatility at the highest level since December 2008, however, PFIX's long put options are probably overpriced.
• I outline key price levels to watch and suggest buying incrementally.

Interest rate volatility, as measured by the ICE BofA MOVE Index ((MOVE)) surged to 198 on Wednesday this week. That's the highest reading since December 2008 during the Great Financial Crisis. As a result, 30-year mortgage rates are now at more than a 3 percentage point premium to the 10-year Treasury yield (6.55% versus 3.40%). Mortgages effectively have an embedded put option since the borrower can put the mortgage rate back to the lender through refinancing to a lower rate in the future.

The same concept holds for one new ETF that is long the short-term Treasury market through traditional ownership of Treasury bills and notes while owning long-term Treasury put options.

Let's take a look at why now may be a good time could to buy Simplify Interest Rate Hedge fund ( PFIX ) but there is one key risk to understand.

Interest Rate Volatility: Highest Since the GFC

According to the issuer , the Simplify Interest Rate Hedge fund, one of 2022's top 10 performing ETFs , seeks to hedge against rising long-term interest rates, and to benefit from market stress when fixed income volatility increases. The fund holds a large position in over-the-counter (OTC) interest rate options intended to provide a direct and transparent convex exposure to large upward moves in interest rates and interest rate volatility.

PFIX can be thought of as a short-term Treasury fund that has outsized upside potential should long-term rates rise. It performs well during rising rate regimes generally, but also offers income. The ETF wrapper gives decent liquidity and tax treatment to holders. PFIX is said by Simplify to be used as a hedge against rising rates that could hurt typical fixed-income portfolios, real estate holdings, and long-duration equity positions.

PFIX Holdings

Launched in 2021, PFIX features an SEC 30-day yield of 2.72% as of March 15 and you will pay an annualized expense ratio of 0.50%, so it is a somewhat expensive way to get Treasury exposure, but you also do not have to go about layering on your own options and hedges.

Right now, shares trade at a material 3.26% discount to NAV, which is a material discount when looking at the premium/discount history. When trading PFIX, be aware that the ETF can feature some illiquidity at times as the 30-day median bid/ask spread is 0.14%, so using limit orders is wise. Volume averages around 50,000 shares.

PFIX Price Premium/Discount to NAV

So PFIX is an ideal choice if you want to express a bearish view on bonds while still collecting some income. With the recent plunge in yields, which I see as being potentially a near-term feature, now could be the time to enter PFIX. Should rates inch back higher following the latest risk-off Treasury buying spree, I expect the fund to outperform.

The key risk, though, is that Treasury rate volatility is so high. So, the value of the put options PFIX purchases may retreat, all else equal. I would like to see rate vol decline while the level of interest rates holds at this lower level for the best buying opportunity.

PFIX nearly doubled from early August last year through mid-October when rates rose sharply. That is when its put options paid off. But then as yields retreated, PFIX underperformed a broad index fund of government bonds. Interestingly, both PFIX and GOVT have risen - that's due to both being long some Treasuries as yields have fallen, but rate volatility has caused the put options PFIX owns to jump in price despite the yield drop.

PFIX: Usually Moves Inverse GOVT Treasury Fund With Extreme Beta

The Technical Take

PFIX appears to have broken out from a consolidation pattern off the October high. Notice in the chart below that shares held the $57 to $60 range. So, long here with a stop under $55 could be a favorable risk/reward play. What's more, there's high volume-by-price in the $60 to $64 range that may cushion further downside. I conceded that technicals on this sort of product may not work quite as well compared to using TA on liquid single stocks and index ETFs.

PFIX: Breaking A Downtrend Resistance Line, Holding mid-$50s Support

The Bottom Line

I think now is a fine time to get long PFIX based on the thesis that rates may rise after plunging due to a risk-off atmosphere over the last two weeks. The risk is that rate volatility is obscenely high right now, so maybe the better approach is to buy in increments with the hope that rate volatility subsides soon.

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