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Deflation Hedge

By Bernie Thurston
September 23, 2021
 

Hedge fund Quadratic Capital Management is launching its second actively managed ETF, following the success of its first inflation-hedging ETF (IVOL), which collected $3.3 billion in two years.

 

The Quadratic Deflation ETF (BNDD) seeks to hedge against a whole bunch of things that can be characterised as “deflation”. This includes lower growth, actual deflation as measured by CPI, negative interest rates and a flattening yield curve.

 

BNDD will try to achieve this by buying long term treasuries or options on them, whose prices mechanically rise when interest rates fall.

 

The fund charges 0.99%.

 

Bernie’s commentary – A bond portfolio already hedges against deflation

Few people know that over the past 40 years, bonds have been the best performing asset class on a risk-adjusted basis. Yes, shares have performed better than bonds. But bonds have performed very well too and with much less volatility. Just look at asset class total returns over the past 40 years. You may be surprised.

 

The big reason that bonds have done so well is deflation. Since the 1970s, governments have done everything within their power to keep inflation down—including wage inflation (real wage growth disconnected from productivity growth in the 1980s). This has created a boon for bonds – especially long duration bonds – and has powered the decades-long bull market.

 

The question I have for this ETF is: why should investors that already own bonds in their portfolios – which hedge against deflation as it is – need this? And why is a deflation hedge ETF going to provide a better hedge than a fund like the Vanguard Extended Duration Treasury ETF (EDV), which binges on 30-year treasuries?

 

A fee of 0.99% is steep and will greatly undermine already slim treasury yields. So my gut feeling is that a justification will be needed. Then again, Quadratic has succeeded before. Their inflation hedge ETF (IVOL) has raked in $3.3 billion, which is a hell of a lot for a small ETF provider with just one ETF. Maybe they can pull it off again.

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