- The Simplify Interest Rate Hedge ETF, run by Harley Bassman, has dominated in 2022.
- Hedging against higher interest rates has been a winning strategy as the inflation fight continues.
- Here’s how Bassman constructed his winning portfolio — and his outlook for rates and inflation.
Harley Bassman doesn’t have much in common with legendary NFL quarterback Tom Brady.
Perhaps the only similarity the two men share, besides the fact that they’ve both had long and successful careers, is that they’ve each recently unretired to chase an attractive job opportunity.
Bassman, who spent most of his decorated 35-year career at Merrill Lynch and PIMCO, came back to the workforce in early 2021 — not to lead a Super Bowl-caliber team, but to become a managing partner at Simplify, an ETF provider.
At his new firm, the market veteran used his background in options trading and started the Simplify Interest Rate Hedge ETF (PFIX). And much like Brady, Bassman’s return from retirement has been a big success: this year, the fund is up 66% and is a top-1% performer, per Morningstar.
Making money from higher interest rates
The name of Bassman’s ETF is a clue as to how the fund manager achieved such strong returns this year, even as stocks and bonds have melted down.
Bassman’s strategy is simply to hedge against interest rates, which have risen dramatically this year as inflation runs rampant. Having exposure to rising rates can offset the losses that stocks, bonds, and real estate have suffered from tighter financial conditions this year.
In the spirit of simplicity, the fund has just two types of assets. In a recent interview with Insider, Bassman said that his fund is only composed of short-dated Treasuries and a seven-year option on the 20-year interest rate struck at 4.25%. He noted that a seven-year time frame allows him to bet on the direction of a move in interest rates without needing to nail the precise timing of it.
“What I wanted to do was to find a product to offer people direct access to rising interest rates,” Bassman told Insider. “Not some trading strategy, not some alpha strategy, any other kind of correlation strategy where ‘if this goes up, then gold should go up or this should happen, the yield curve would steepen.’ It’s direct, dry: rates go up, I make money; rates go down, I lose money.”
But while the strategy is straightforward, it’s difficult for nonprofessional investors to replicate. The fund uses special contracts from the International Swaps and Derivatives Association (ISDA), which Bassman said allows him to “trade on even footing with all the big boys.”
In a perfect world, Bassman said, no one would need to invest in his fund. But in a volatile market environment, a hedge against a traditional 60-40 portfolio can pay off in years like this.
“When you buy car insurance, you don’t hope to crash your car,” Bassman said. “But if you do, you better have it, or you’ve got problems.”
Unlike most ETF managers, Bassman doesn’t believe that investors should put as much money into his fund as they can. Instead, he said that a 5% allocation of an investor’s portfolio is plenty. Even more unusual, Bassman said investors should hope that his fund loses money if they invest in it.
“The idea that rates go down and you buy this insurance policy — truth be told — is a better strategy,” Bassman said. “You make even more. You prefer that. Your preferred strategy is to get wrong on rates and bond yields go down.”
What’s next for interest rates and inflation?
Investors got clarity on the rates front when the Federal Reserve announced on Wednesday that it was raising the Federal Funds rate by 75 basis points (0.75 percentage points) to slow inflation.
Markets are betting that the bulk of the rate hikes are in the rearview mirror. But Bassman disagrees, and instead said that rates could rise far above their current 3% to 3.25% range as high home prices remain high and a tight labor market keeps inflation hotter than expected for longer.
“I think the market’s dead wrong,” Bassman said. “The Fed’s taken rates up a lot. I think they’re going through 4% on the front end because they’ve got to stop inflation, and they’re going to do it the old-fashioned way and put us in a recession.”
A Fed-induced recession would be painful for millions, but it’s ultimately what’s best for the economy, Bassman said. The middle class is getting pinched most by higher prices, in his view, because the lower-income households can get government support while the rich can lean on their excess savings, some of which — ironically — came from the government.
“If you take unemployment from 3.5% to 5% — because that’s what it’s going to take to go and chill things down — you hurt 1.5% of the population, but you help 60%,” Bassman said. “This is the bloody math of financial war.”
Fed chair Jerome Powell will likely err on the side of hawkishness because he won’t want to be remembered as the head of the US central bank that let inflation run rampant, Bassman said. With that in mind, investors should ignore Bassman — and his fund — at their own risk.
“If you think that rates have peaked and there’s no chance that rates will go higher, don’t buy it — please!” Bassman said. “But I doubt — I sincerely doubt — anyone could say for sure that they know rates ain’t going higher.”