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ETF Plays for the Bond Game

Mutual fund investors can buy inverse bond funds if they want to make a few bucks from the recent spike in Treasury bond yields. But what about exchange-traded fund investors? What options do they have in a rising rate environment?

The yield on the benchmark 10-year Treasury bond has risen from 4.5% to more than 5% since the start of 2006. As a result, the two largest inverse bond funds, the $1.53 billion (RYJUX)Rydex Juno Investor fund and the $414 million (RRPIX)ProFunds Rising Rates Opportunity fund, have jumped 9.7% and 12.5%, respectively.

The trick to these specialty mutual funds is that they increase in value if interest rates go up, a financial feat accomplished by portfolio managers short-selling Treasury bonds.

As of yet, there are no ETFs that provide a similar inverse function, though it may not be long for such an offering, considering the flurry of new ETFs rolling off the assembly line.

Until that day, ETF investors will have to make do with fixed-income trading vehicles that can track fixed-income indices.

If you think bond prices are going to fall (meaning yields will rise), one option would be to simply sell short the most popular fixed income ETF, the Lehman 20+ Treasury (TLT) fund. The TLT tracks the price and yield performance of the long-term sector of the U.S. Treasury market as defined by the Lehman Brothers 20+ Year Treasury Index.

One of the main advantages of ETFs over mutual funds is the ability to sell them short. In this case, an investor would try to profit by selling the TLT high and buying it back after the spike in yields drives the price down.

Before pulling the trigger, however, investors should note the major risk in shorting the TLT: An economic slowdown could cause interest rates to do an about-face and approach zero. Such an event would cause TLT prices to spike, forcing investors to cover their shorts at a loss.

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