With over $23 billion of assets under management, ProShares is one of the leading providers of leveraged and inverse ETFs. Presently, they are managing 132 funds in total and their current lineup consists of products across asset classes including equity, fixed income and even funds targeting volatility benchmarks (see Use VIX ETPs to Profit From Market Volatility). The company looks to expand its reach in the bond space, making another addition to their inverse offering in the long term Treasury bond space with the ProShares UltraPro Short 20+ Year Treasury ETF (TTT).
Given the launch and great popularity of the company’s UltraShort 20+ Year Treasury ETF (TBT) the launch can be viewed as a strategic move from ProShares in order to strengthen their already dominant position in the geared ETF space. Additionally, it could be coming at a great time since bonds are at record highs and many are forecasting a crash in Treasury bonds at some point in the near future (see Forget About Low Rates With These Three Bond ETFs).
In fact, yields are at pretty low levels with current rates around 3.27%, with yearly highs coming in at about 4.45%. However, going forward it is believed that the yields have significant potential to increase in the near future, leading to a fall in the benchmark index possibly resulting in good performance of funds in the space.
Geared funds are also known as leveraged and inverse funds. With an increasing appetite for risk among the investors, these products have gained tremendous popularity over the recent years given their high risk high reward characteristics.
Traditionally leveraged funds provide -1x, 2x or 3x the exposure of the benchmark performance. For example, if the benchmark rises by 1%, the ETF will rise by 2% and vice-versa, for a fund that provides 2x the exposure. On the other hand an inverse leveraged ETF bets against the positive movement of the underlying index, usually over a single day.
In the case of inverse products, the opposite is true, although time periods are usually one day as well. So in this case, if the benchmark falls by 1%, the fund gains 2%, however, if the index rises by 1%, the fund would lose 2% for an inverse leveraged fund that provides -2x the exposure (see UBS Launches Monthly Leveraged Real Estate Securities ETN (RWXL)).
TTT in focus
The newly launched TTT is an inverse bond ETF that seeks to provide -3x the exposure of the daily performance of the Barclays Capital 20+ Year U.S. Treasury Bond Index, before adjustments for fees and expenses of the fund. The index tracks the performance of U.S Treasury bonds with maturities greater than or equal to 20 years.
The fund short sells the bonds in order to provide -3x the exposure. However, the fund may buy derivatives and swaps instead of shorting the debt securities. Like most of its counterparts in the geared ETF space, TTT is quite pricey as it charges investors 95 basis points a year in fees and expenses.
The fund employs daily rebalancing techniques as measured from one NAV calculation to the next, which gives rise to compounding of daily returns. This leads to a difference between the ‘standard’ -3x the returns of the benchmark (as specified by the fund) and the actual daily returns of the fund.
This phenomenon works really well during a consistent downtrend, (see Is The Bear Market For Bond ETFs Finally Here?) where the actual compounded positive returns of the fund, exceeds the standard -3x the compounded negative returns of the index. Or during a consistent uptrend, where the actual compounded negative returns of the fund is less than the standard -3x the compounded positive returns of the index, leading to a win-win situation for the investor during both market trends. However, during periods of high volatility, this phenomenon can hurt the investor leading to larger losses than what some investors might initially expect.
The fund typically targets bonds at the longer end of the yield curve (i.e. 20 years and above) which are more sensitive to the changes in interest rates. Since yields and prices of bonds move in opposite directions, a slight increase in the yields may result in a significant decrease in the prices of bonds and a slight decrease in yields will result in a significant increase in its prices. Technically speaking, long term debt securities have greater duration and convexity leading to higher volatility than their short term counterparts.
ProShares as a fund family is the market leaders when it comes to the inverse and ETF space. The new product launch is just another small offering in its already large base of geared exchange traded products. However, talking of individual funds, the newly launched fund may face severe competition from certain experienced funds in this space:
PowerShares 3x Short 25+ Year Treasury Bond ETN (SBND)
Launched in July 2010, the inverse leveraged fund tracks, before fees and expenses, the price and yield performance of the Deutsche Bank Short U.S. Treasury Bond Futures Index and gives exposure of 300% of the short performance of the Ultra T. Bond Futures. The index short sells Ultra T-Bond Futures, which are the future contracts of U.S Treasury Bonds that do not mature until at least 25 years from now.
The index has AUM of $ 23.4 million and currently has an expense ratio of 0.95%. This fund being an ETN will incur no tracking error and will track the index perfectly since it will not buy or sell securities in the benchmark (see ETFs vs. ETNs: What’s The Difference?). However, the fund has experienced dismal performance returning -60.75% in the past one year period.
Direxion Daily 20 Year Plus Treasury Bear 3x Shares (TMV)
This fund seeks investment results of 3x the inverse performance of the NYSE 20 Year Plus Treasury Bond Index by creating short positions in various derivative securities that provides leveraged and unleveraged positions in the index. The benchmark tracks the performance of the long term U.S Treasury Bonds having maturity of 20 years or more.
The AUM of the fund is $367.8 million and it has an expense ratio of 95 basis points. The fund has experienced significant negative returns of 64.38% in the past one year, thanks to its leveraged position and the oscillating market of long term Treasury bonds.
ProShares UltraShort 20+ Year Treasury (TBT)
This fund was launched by ProShares in mid 2008 and was ProShares’ second inverse ETF offering in the long term Treasury bond space. Compared to the newly launched fund, TBT significantly reduces volatility as it provides -2x the daily performance of the same index instead of -300%.
However, this fund is also exposed to compounding risk as it employs daily rebalancing techniques. Nevertheless, the fund is extremely popular and has seen a whopping $ 3.79 billion worth of inflow in its asset base and an average daily volume of 9.27 million shares. Due to its -2x exposure, the fund has performed relatively better than the above two funds, returning -47% in the past one year.
Given these above numbers, it is prudent to note that TTT may see a significant amount of inflows in its asset base in the near future. The new ETF also enjoys the high brand quality that comes with being a part of the market leader in the inverse and leveraged ETF space. However, these products fall under the “high risk, high reward” category of financial instruments and investing in them involves daily portfolio tracking and thus is not suitable for all investors.
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