The Impact of Crude Oil Investments in Bond Portfolios: Can Oil Serve as a Hedge Against Long Term Bonds?

Abstract

The specter of rising interest rates in the US has caused many to consider the impact this will have on the traditional “anchor” to the portfolio: US Treasury bonds. From a mathematical point of view, rising interest rates unambiguously reduce the value of long duration bond holdings, particularly those with low or zero coupons. As investors reposition their portfolios for anticipated macroeconomic conditions, they are searching for alternative investments that can mitigate the potential capital losses in their bond holdings. This paper examines the relationship between long term bonds and crude oil (as measured by the exchange traded proxies, iShares 20 Year Treasury Bond [NYSEArca: TLT], iShares 7-10 Year Treasury Note [NYSEArca: IEF], the United States Oil Fund LP [NYSEArca: USO], the iPath S&P 500 GSCI Crude Oil TR Index [NYSE: OIL], and the iShares Dow Jones US Oil & Gas Exploration & Production [NYSEArca: IEO] respectively); and the possible effects investments in oil may have in diversifying a predominantly bond-oriented portfolio.

Keywords: bonds, oil, correlation, oil and gas, fixed income, diversification, sury

JEL Classification: A1, E44, E58, G1, G10, G11