Most weeks, ETF flows follow some sort of a pattern:Big funds gains assets, big funds lose assets. Then there are weeks like last week where one fund has a near-7,000 percent (not a typo) increase in assets, and we are left scratching our heads.
Last Wednesday, the little-followed, largely overlooked ProShares Ultra 7-10 Year Treasury ETF (UST) went from $12 million in assets under management to more than $833 million overnight.
The increase in assets of more than almost 6,000 percent overnight was enough to catch our eyes on its own, but the fact that it accompanied a 53 percent increase in assets in a similar, multibillion-dollar ETF—the iShares Barclays 3-7 Year Treasury Bond Fund (IEI)—really rang the alarm bells.
In the five days through last Thursday, there were more than $2.5 billion in net creations in the two funds, and on Friday, UST had added another $240 million in assets. In other words, someone is clearly making a huge bet on these two funds that target the middle of the Treasury curve.
The UST trade is especially aggressive, considering it is part of the “Ultra” line of products from ProShares, whose promised returns are equal to two times the daily return of the reference index.
In the case of U.S. Treasurys, that means whoever is responsible for these outsized inflows is not only betting hard on a further decline in yields in the 7- to 10-year pocket of the curve, but doing so with leverage.
That may help explain why that additional $240 million in assets came into the fund between Friday and Monday as the daily reset of the most leveraged funds requires an investor to “true-up” his or her exposure due to the “path-dependent” nature of levered fund returns.
Still, it’s hard to look at these two trades in isolation given the magnitude of these inflows. When two similar, albeit different, strategies see such massive inflows, it is hard not to point fingers at institutional investors.
Institutions are the most likely candidates to put on trades of this scale, and to use product pairs—sometimes including levered and inverse—to make a play on a curve shift or in an attempt to extract volatility.
What’s curious about these trades is the timing of them. Both of the big inflows came after Federal Reserve Chairman Ben Bernanke and company’s comments were released.
In other words, the somewhat-surprising news that the Fed was willing to potentially expand monthly asset purchases as opposed to simply considering when to slow them was already public knowledge. Any short-term change in interest rates and the shape of the yield curve had likely already been baked in in the short term.
It could be—and this may be the cynic in me talking—that this large institution has some key information that the public has yet to see. After all, given the Libor scandal, revelations of early releases of labor statistics, and the now blossoming ISDA-fix inquiries, it’s hard not to at least wonder.
Then again, a couple billion of inflows into ETFs, whether they are levered or not, represents little more than a drop in the massively liquid bucket that is the market for U.S. Treasury instruments. If anyone of any real size wanted to make a bet that was based on real information, they would likely do so under the ever-so-convenient veil of the over-the-counter derivatives market.
The truth, as always, is probably somewhere in the middle. It’s likely the institution that put on this trade is betting that the Fed’s latest statement signals the central bank’s intent to buy Treasurys in the middle of the curve for as far as the eye can see.
Given the Fed’s commitment to potentially increasing the scale of asset purchases in a scenario where economic growth sputters, betting on continued yield compression in this portion of the curve makes sense.
Furthermore, since yields are already so low, it could be that the institution in question believes that any further decline in yields will be small in magnitude, and leveraging the bet on it is the only way to make the risk/reward equation palatable.
It is always a fool’s errand to try and get inside the mind of an institutional investor, especially when you have no idea which one it is, or what information it is considering.
This informational asymmetry is ultimately one of the defining characteristics of the market, particularly as it relates to fixed income. At the same time, it would be foolish to ignore such a massive inflow and not at least sit and wonder what is going on.
At the time this article was written, the author held no positions in the securities mentioned. Contact Paul Baiocchi at email@example.com.
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