Monday Money Tip: Your portfolio as economy recovers

If America's economic rebound continues, and small public companies keep growing, there's a way to express that in your portfolio. It's a popular exchange-traded fund that tracks the small-cap segment of the stock market: the iShares Russell 2000 Growth Index Fund (symbol: IWO).

Wall Street institutions use IWO, as do smaller investors like Kevin Tierney of KJT Investments, who manages about $25 million in client assets. The iShares Russell 2000 Growth Index ETF tracks small-cap growth stocks, and seeks to mimic the performance of the index.

"I began moving some clients into IWO in January because I thought small caps were going to outperform large caps, and they really have," says Tierney, whose office is in New York City.

"In smaller, individual investor accounts it's very useful," he says.

Tierney uses two other ETFs to hedge against rising interest rates: the ProShares UltraShort 20+ Year Treasury (TBT) and the ProShares UltraShort Lehman 7-10 Year Treasury (PST).

These aim to make money when bond yields rise and bonds fall in value.

The ETFs seek returns that are twice (200 percent) the inverse (or opposite) of the daily performance of the 20-year Treasury and the 7-to-10-year Treasury note, respectively. Got that?

If rates rise, bond prices will likely fall. So TBT and PST could serve as a hedge against rising rates.

Be extremely careful, though, since these particular ETFs are supercharged, using "leverage," or borrowed money, to bulk up the bet.

"It's very hard to short bonds," Tierney says. "But with these ETFs, as yields go up, the value of the ETF goes up. It's a way to short bonds without a lot of expense. But they won't make money until rates go up."

If you're not comfortable with leverage, stay away from ETFs that double or triple your bet using borrowed money.

"We were among the first users of ETFs. In our small-cap portfolios, we might use an IWO as a cash substitute," says local investor Ted Aronson, cofounder of AJO on South Broad Street, which manages more than $25 billion.

But he avoids levered ETFs.

"The notion of an amplified or levered fund has really twisted the marketplace," Aronson says. "We stay away from levered ETFs with a 10-foot pole. They're insane."

How would Aronson hedge against rising interest rates? Simple, he says.

"Don't own bonds."