Inflation is kryptonite to bonds and gold is an inflation hedge. What if we combine these two great tastes together like Reese's mixture of peanut butter and chocolate.
The Strategy Shares Gold-Hedged Bond ETF (BATS:GLDB) does exactly that. It's both a way for a bond fund to hedge against the threat of inflation, and a gold fund to pay a yield. The strategy is to help investors generate income that maintains its purchasing power by providing exposure to two markets, bonds and gold. It tracks the Solactive Gold-Backed Bond Index.
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Bond prices are sensitive to changes in inflation, because inflation erodes the bond's value. When inflation increases, it creates a chain reaction that leads to central banks boosting interest rates. When interest rates rise, bond prices fall.
Bonds are fixed-income investments that pay a consistent stream of interest payments to their investors. That means the dollar amount remains the same, no matter what the interest rate is. Higher interest rates force bond prices to fall to keep the bond's interest payments competitive with the going rate.
Last year inflation spiked, with the Consumer Price Index, one of the government's key inflation gauges, rising more than 9% for the year ended June 2022. That's the highest inflation rate in 40 years.
When inflation gets out of control, central banks raise rates to cool down rising prices. The Federal Reserve raised rates seven times in 2022 to a range of 4.25%-4.50%. So far this year, it's raised rates twice to a range of 4.75%-5.00%.
Called a hedge against long-term inflation, gold has a 5000-year history of maintaining its value. When inflation erodes the dollar's value, it takes more dollars to buy the same amount of gold. Over the past year, gold has held its value, while the dollar has not. For bondholders, combining bonds falling in value with rising gold prices creates a portfolio hedged to help minimize losses.
Now, if you flip the purpose of the Gold-Hedged Bond ETF upside down, it becomes a gold lover's dream. Because gold is a commodity, it doesn't pay a dividend or interest payment. That's ok when the price of gold rises. But when the dollar is stable, gold sits like a lump of coal, giving off no money.
Yet, when people experience a loss of purchasing power, gold acts as a hedge against inflation. Since the price of gold rises when the dollar falls, it's also a short position on the dollar.
If you want exposure to gold, but are hesitant because it doesn't pay a dividend, combining gold with the bond portfolio guarantees a monthly payout. It's a stacked-return product that provides exposure to two different assets.
"Since 1973, when the Bretton Woods System was no longer in place, the value of the U.S. dollar has eroded by more than 80% because of inflation," according to Strategy Share's website. "In recent decades, the money supply has grown at an unprecedented rate, with the M1 Money Supply increasing by more than 1200% since 2008."
With interest rates already high and the U.S. losing purchasing power as it experiences a rising inflationary trend, the Gold-Hedged Bond ETF is an interesting idea for investors looking for exposure to a high-grade corporate-bond portfolio in an inflationary environment.
The fund's holdings seek "100% exposure to the U.S. investment-grade corporate bond sector." Then it gets an overlay of a gold inflation hedge in the form of a total-return-swap that tracks the near-month gold-futures contract, giving it full exposure to the price of gold. And investors receive monthly payouts.
In 2022, the fund lost 19.80 percent of its value compared to the 13.06 percent drop on the iShares Core US Aggregate Bond ETF, according to Morningstar.com. The 12-month yield for GLDB is 2.67%, according to Morningstar, while AGG's is 2.47%. Founded May 2021, the fund charges an expense ratio of 0.79 percent.
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However, last year the rate hikes caused bond prices to fall the most in history -- 27 percent for long-term investment-grade bonds -- according to Edward F. McQuarrie, professor emeritus, Santa Clara University. So, compared to that, the Gold-Hedged Bond ETF did well. And with bonds kicked down so low, there is plenty of upside potential in the fund. Year to date, GLDB is up 10.46 percent. (3/30/23)
The fixed-income exposure analysis by Morningstar based on the long position of the fund's holdings says 11% of the portfolio is in AA-rated bonds. About 23% of the portfolio is in A-rated bonds, and around 45% of the portfolio is BBB-rated bonds.
The breakdown of the sector weightings of the bonds:
Cash 17.7%
Financials 16.5%
Consumer Staples 10.5%
Energy 9.3%
Information Technology 9.3%
Communications Services 9.3%
Health Care 7.3%
Consumer Discretionary 51%
Real Estate 3.1%
Materials 2.4%
Utilities 2.4%
Source: Strategy Shares 12/31/22
This content is for informational purposes only and is not intended to be investing advice.