The funds created to fight the Fed's rising rates

Ultrashort and short-term bond products have nabbed $6.6 billion in new assets this year.

When executives of ETF Managers Capital rang the bell of the New York Stock Exchange in early December, the size of the $15.6 million exchange-traded fund they command that bets on higher interest rates wasn't as notable as its ticker symbol and the timing: RISE came into the spotlight just as the Federal Reserve's first interest-rate hike in nine-plus years became all but certain.

The Sit Rising Rate ETF is not alone. It's one of many ETFs that have been springing up to play the long-expected rise in rates. "There was a flurry of launches over the last eight months," said FactSet senior analyst Paul Britt. "The concern has been out there for years, so there have been all kinds of products."

The Sit Rising Rate ETF requires an understanding of how interest-rate risk can be hedged by achieving negative duration in Treasury bonds using futures and options. Another example of this negative duration ETF is the WisdomTree Barclays U.S. Aggregate Bond Negative Duration Fund (AGND).

Not your flavor? Most ETF investors have agreed up to now: Two WisdomTree negative duration ETFs — the ticker for the other is HYND — have less than $14 million each in assets, and they've been around since 2013.

"In a rising rate environment, both investment-grade and high-yield bonds are likely to underperform," said a WisdomTree spokeswoman. "Unhedged bonds will generally do poorly, that's why we've decided to hedge our bonds," she said.

Referencing the boom in currency hedged equity ETFs over the past few years due to international central banking policies, she added, "Duration hedging hasn't yet had its 'hedge the yen' moment ... but like currency-hedged ETFs, duration-hedged ETFs may start finding a place after Fed announcement for managing duration exposure in a broader bond-portfolio context."

Now might finally be their, and RISE's, time, but the beginnings of interest-rate normalization affect investments of all kinds, and that can overcomplicate the situation for investors.

From professionals to coupon-clipping grandmas, all kinds of investors have stakes in one or more products that will become more or less valuable (or risky) depending on what Fed Chair Janet Yellen and the Fed do for the next year or more.

Certificate of deposit rates may rise a little, but chief analyst Greg McBride warns savers not to get their hopes up, since widespread available deposits will mean banks don't need to bid higher for them.

Utility stocks could get hurt some, since their dividends will be relatively less valuable in a world where 10-year Treasury bond yields are not as low as the 2.23 percent they commanded on Dec. 7.

But for many investors, the simplicity of ETFs makes them an attractive way to think about playing, or hedging against, the rise in rates, said Todd Rosenbluth, ETF research director at S&P Capital IQ in New York.

"If you're holding funds with investments of longer duration — more than five years — and you sought yield by buying longer maturities, you probably want to revisit that," Rosenbluth said. "Those funds will get hurt more as rates rise."

The reason, he said, is simple: Longer bonds lock you into the low returns of the last few years for longer into the future. That's a lesson investors have taken to heart. Ultrashort and short-term fixed-income products combined have gathered $6.6 billion in new assets this year through November, versus only $307 million for long-term products, according to State Street Global Advisors (SSgA) research.

Rosenbluth suggested three funds — spread across the risk spectrum from short-term, conservative bonds to high-yielding bonds — that are representative of different approaches an investor might take to rising rates. S&P Capital IQ thinks the Federal Reserve will raise the Federal Funds rate four times to reach 1.25 percent by the end of next year, from a range of zero to 0.25 percent now. The so-called Fed funds rate is what banks pay to borrow money from each other.

"If you're holding funds with investments of longer duration – more than five years – and you sought yield by buying longer maturities, you probably want to revisit that. Those funds will get hurt more as rates rise." -Todd Rosenbluth, ETF and mutual fund research director at S&P Capital IQ

For investors searching for yield and with a risk profile that is more aggressive, even with the recent turmoil in the high-yield sector, an investor can still look into junk bond funds.

The best performing junk-bond ETF this year isn't exposed to the U.S. high-yield market: It's the the Market Vectors Emerging Market High Yield Bond ETF (HYEM), and it's up 6.6 percent this year.

Rosenbluth said the SPDR Barclays Short-Term High Yield Bond Fund, whose memorable SJNK ticker symbol truncates "short junk," has an attractive yield of 6.7 percent. And even though there is more credit risk in those bonds, junk default rates are expected to tick up to 3.3 percent by next year, from 2.5 percent this year. The extra yield should let the fund more than hold its own, Rosenbluth said. And average duration of bonds in the ETF is 2.4 years.

Shares of SJNK have fallen more than 4 percent this year and fell a little more than 2 percent in November, and this year it has had worse performance than most junk funds. Its top holdings include bonds of hospital providers HCA Holdings and Community Health Systems, as well as student-loan servicer Sallie Mae.

A shorter-term fund that offers less exposure to principal loss in the underlying bonds is the iShares 1-3 Year Credit ETF (CSJ). Rosenbluth said that with a very low 0.2 percent expense ratio, the average bond CSJ owns has a duration of just 1.9 years. It pays a 1.3 percent yield and is invested mostly in investment-grade corporate bonds, which have little default risk, and some agency and government bonds, he said.

The CSJ fund is up about 0.8 percent this year, ranking near the middle of its category, according to ETF Database.

A mutual fund like DoubleLine's Low Duration Bond Fund (DBLSX) tries to split the difference, Rosenbluth said. It has a higher-yielding mix of bonds than the iShares short-term fund but keeps its average maturity at 1.2 years. Most of its portfolio is investment-grade, but the fund pumps up returns by buying some bank loans with good credit prospects, he said. But even its returns have averaged only about 1.2 percent a year, according to Morningstar.

An investor unimpressed by bond returns and reluctant to get into high-yield may just want to keep playing in U.S. stocks, which S&P Capital IQ thinks will rise modestly next year. But investors who want extra security will find bonds paying at least a little more income after years of near-zero rates.

By Tim Mullaney, special to