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Interest Rate Risk: The Main Risk Factor for NEAR ETF

March 20, 2024 | by stockcoin.net

interest-rate-risk-the-main-risk-factor-for-near-etf
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The NEAR ETF (BlackRock Short Duration Bond ETF) has undergone a transformation, shifting from a conservative fund to one that now holds riskier assets with an extended duration profile. This transition has resulted in an increase in the fund’s price sensitivity, positioning it to potentially benefit from a decrease in interest rates. Despite the higher duration, the credit profile of the fund remains predominantly in the top ratings bands. The correlation between Fed Funds and 2-year Treasuries suggests that as the Federal Reserve lowers rates, NEAR will reap the advantages of its duration profile. With a revised composition that includes treasuries, ABS, and CLOs, with a focus on short-dated corporate paper, the primary risk factor for NEAR is now interest rate risk. As a result, the fund’s volatility profile has shifted due to its exposure to interest rate movements. Based on the author’s expectations of rate cuts by the Fed in the coming year, NEAR could potentially deliver a total return of 7% over the next 12 months.

Introduction

The NEAR ETF, also known as the BlackRock Short Duration Bond ETF, has recently undergone a significant transformation. The fund has transitioned from a cash-like fund to one that holds riskier assets with a higher duration profile. This change has important implications for investors who are looking for exposure to short duration bonds with a potential for attractive returns. In this article, we will provide an overview of the NEAR ETF, discuss its credit profile, analyze its price sensitivity and interest rate dynamics, examine its correlation with Fed Funds and 2-year Treasuries, and explore the fund’s composition and main risk factor. We will also discuss the author’s expectations for rate cuts and the potential total return for the NEAR ETF.

Interest Rate Risk: The Main Risk Factor for NEAR ETF

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Overview of NEAR ETF

The NEAR ETF has traditionally been known as a cash-like fund, providing stable returns with minimal risk. However, in recent times, the fund has transitioned to a new investment strategy involving the allocation of assets with higher duration. This change is aimed at capturing higher yields in a low-interest-rate environment. While this shift may introduce some level of risk, it also presents opportunities for investors looking to diversify their portfolios with short duration bonds.

Transition to higher duration assets

The transition to higher duration assets in the NEAR ETF is an important development for investors. By extending the duration of the fund’s holdings, it becomes more sensitive to changes in interest rates. This increased price sensitivity is a double-edged sword. On one hand, if interest rates decrease, the fund’s extended duration will likely result in higher returns for investors. On the other hand, if interest rates increase, the fund’s price will be more negatively impacted compared to its previous cash-like profile.

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Interest Rate Risk: The Main Risk Factor for NEAR ETF

Credit profile of the fund

Despite the increase in duration, the credit profile of the NEAR ETF remains strong. The fund’s holdings are primarily concentrated in the AAA or AA ratings band, indicating a high level of creditworthiness in the underlying assets. This credit profile provides investors with confidence in the stability of the fund’s returns, even as it takes on increased duration risk.

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Price Sensitivity and Interest Rates

One of the key factors affecting the NEAR ETF’s performance is its price sensitivity to changes in interest rates. With the recent transition to higher duration assets, the fund’s price sensitivity has increased significantly. This means that small changes in interest rates can have a larger impact on the fund’s price. As a result, investors should closely monitor interest rate movements to assess the potential impact on the NEAR ETF.

Interest Rate Risk: The Main Risk Factor for NEAR ETF

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Increased price sensitivity

The increased price sensitivity of the NEAR ETF can be attributed to its extended duration. Duration measures the sensitivity of a bond or a bond fund’s price to changes in interest rates. As the duration of the NEAR ETF has increased, the fund becomes more exposed to interest rate movements. This heightened price sensitivity can result in larger gains or losses for investors, depending on the direction of interest rates.

Benefit from decreasing interest rates

While increased price sensitivity poses a potential risk, it also presents an opportunity for investors. If interest rates decrease, the NEAR ETF’s extended duration will work in its favor, resulting in higher returns. This is because the fund’s longer-dated assets will experience larger price increases compared to their shorter-dated counterparts when interest rates decline. Investors who believe that interest rates will continue to decrease may find the NEAR ETF an attractive investment option.

Interest Rate Risk: The Main Risk Factor for NEAR ETF

Correlation between Fed Funds and 2-year Treasuries

An important consideration for investors in the NEAR ETF is the correlation between the Federal Funds Rate and 2-year Treasuries. The Federal Funds Rate is the interest rate at which depository institutions lend funds held at the Federal Reserve to other depository institutions overnight. It serves as a benchmark for short-term interest rates. 2-year Treasuries are U.S. government debt securities with a maturity of two years. The correlation between these two variables is significant because it provides insights into how changes in the Federal Funds Rate can impact the NEAR ETF.

Implications for NEAR ETF

The high correlation between the Federal Funds Rate and 2-year Treasuries suggests that as the Federal Reserve cuts rates, the NEAR ETF will benefit from its extended duration profile. This is because the fund’s longer-dated assets will experience price increases in response to the decline in short-term interest rates. This relationship between Fed Funds and 2-year Treasuries provides investors with a useful framework for assessing the potential impact of monetary policy decisions on the NEAR ETF’s performance.

Interest Rate Risk: The Main Risk Factor for NEAR ETF

Composition of NEAR ETF

As the NEAR ETF has evolved, its composition has also changed. The fund now includes a mix of treasuries, asset-backed securities (ABS), and collateralized loan obligations (CLOs). This diversified portfolio allows the fund to capture a range of income opportunities across different sectors and asset classes. Additionally, the NEAR ETF has a focus on short-dated corporate paper. This allocation strategy aims to balance the fund’s yield potential while maintaining a relatively low level of risk.

Mix of treasuries, ABS, and CLOs

The inclusion of treasuries, ABS, and CLOs in the NEAR ETF’s composition provides investors with exposure to different segments of the fixed income market. U.S. Treasuries are considered to be one of the safest investments available, backed by the full faith and credit of the U.S. government. ABS represents securities backed by pools of assets such as mortgages or auto loans, while CLOs are structured finance products that pool together loans made to companies. This mix of assets allows the NEAR ETF to capture opportunities for generating income while diversifying risk.

Focus on short-dated corporate paper

The NEAR ETF’s focus on short-dated corporate paper aligns with its objective of providing investors with exposure to short duration bonds. Short-dated corporate paper refers to bonds or other debt instruments issued by corporations with relatively short maturities. These securities typically offer higher yields compared to treasuries, making them an attractive investment option for those seeking income. However, it’s important to note that short-dated corporate paper may also carry higher levels of credit risk compared to government-backed securities.

Main Risk Factor: Interest Rate Risk

One of the main risk factors associated with the NEAR ETF is interest rate risk. Interest rate risk refers to the potential impact of changes in interest rates on the value of fixed income securities. As the NEAR ETF holds assets with extended durations, it becomes more exposed to fluctuations in interest rates. If rates increase, the fund’s longer-dated assets are likely to experience price declines, resulting in a negative impact on the fund’s overall performance. Investors should carefully consider their risk tolerance and investment objectives before investing in the NEAR ETF.

Volatility profile of the fund

Another aspect of interest rate risk is the impact it has on the volatility profile of the NEAR ETF. Volatility measures the degree of variation in the fund’s price over time. As the fund’s holdings become more sensitive to interest rate movements, its volatility profile may change. This means that the NEAR ETF’s price may experience larger fluctuations compared to its previous cash-like profile. Investors who are sensitive to price volatility should carefully assess whether the NEAR ETF aligns with their risk tolerance.

Exposure to interest rate movements

The NEAR ETF’s exposure to interest rate movements is a key consideration for investors. Given the fund’s extended duration and increased price sensitivity, its performance is closely tied to changes in interest rates. Investors who anticipate a decrease in rates may find the NEAR ETF attractive due to its potential for higher returns. Conversely, those who expect rates to rise may choose to allocate their funds elsewhere in order to minimize the potential negative impact of increasing rates on the NEAR ETF’s performance.

Expectations for Rate Cuts

The author of this article predicts that the Federal Reserve will cut interest rates this year. This prediction is in line with market expectations and reflects the current economic environment characterized by low inflation and subdued economic growth. If the Federal Reserve indeed implements rate cuts, the NEAR ETF is likely to benefit from its extended duration profile. This would result in higher returns for investors who hold shares of the fund.

Potential impact on NEAR ETF

The potential impact of rate cuts on the NEAR ETF is twofold. First, the extended duration of the fund’s holdings would generate higher returns as interest rates decrease. Second, the fund’s focus on short-dated corporate paper would allow it to capture income opportunities in a low-rate environment. Both of these factors contribute to the potential for attractive total returns for investors who hold shares of the NEAR ETF.

Author’s prediction of 7% total return

Based on the expectation of rate cuts and the NEAR ETF’s investment strategy, the author predicts a potential total return of 7% for the fund in the next 12 months. This prediction takes into account the fund’s extended duration, its focus on short-dated corporate paper, and the potential benefits from declining interest rates. Investors who are seeking potential income and total return may find the NEAR ETF an appealing investment option based on the author’s prediction.

Timeframe for the return

The timeframe for the potential 7% total return on the NEAR ETF is set at the next 12 months. This timeframe aligns with the author’s prediction and reflects the anticipated impact of rate cuts on the fund’s performance. It’s important for investors to keep in mind that total return predictions are based on assumptions and expectations, and actual results may vary. Investors should carefully consider their investment horizon and risk tolerance before making any investment decisions.

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