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Huge T-Note ETF Inflows Back Fed Policy

Olly Ludwig and Cinthia Murphy


Investors—probably institutions—have been plowing sizable amounts of capital into the middle of the Treasurys yield curve this week, quite likely because they are starting to truly believe the Federal Reserve is telling the truth when it pledges to keep rates low, even as equity markets reach new highs.

The latest eye-popping allocation was that $822 million that was pumped into the ProShares Ultra 7-10 Year Treasury ETF (UST) on Wednesday. The creation took what had been a $12 million fund as of Wednesday’s close and, overnight, turned it into an $833 million fund, according to data compiled by IndexUniverse. A ProShares official confirmed the inflows.

UST’s nearly 7,000 percent increase in assets under management followed by a day a massive inflows into the iShares Barclays 3-7 Year Treasury Bond Fund (IEI) amounting to $1.22 billion that lifted the fund’s total assets by 53 percent to $3.5 billion in one day.

The massive popularity of IEI and UST—the latter a double-exposure fund that rebalances daily—seems to reflect a broader trend of institutional money finding its way into lower-cost, liquid bond funds in ETF wrappers, analysts and ETF industry sources say. IEI added $161.5 million on Thursday, lifting its assets 4.6 percent to $3.68 billion.

More to the point, this week’s Fed stance that it plans to stay the course when it comes to monetary policy might also have had something to do with demand for IEI and UST, as investors find encouragement to “ride the interest-rate risk,” according to IndexUniverse Vice President of Research Gene Koyfman.

“The idea may be that if Fed policy isn't likely to change, and the very short-end of the curve offers absolutely no yield that the next step is there will be continued pressure on the intermediate part of the curve, said Koyfman, who specializes in fixed-income ETFs.


“I'd look for an outflow out of a shorter-duration Treasury fund that corresponds to this big move,” Koyfman added. “If that were the case, then a good guess is that someone just decided they’re willing to ride the interest-rate risk, as the Fed is unlikely to change course in the foreseeable future.”

In fact, there aren’t clear signs in the ETF market on the short end of the Treasurys curve, so the probability is that institutions are reallocating cash. Cash is no different that short-dated bonds, in that money in the bank is also a slow-bleeding, money-losing proposition too.

Indeed, with short-dated yields and money market funds yielding about zero, that means their yields are in fact negative on a “real” basis after accounting for inflation, Koyfman noted.




A Safe Reach For Yield?

Perhaps crucial to index investors who benchmark performance with great care, IEI’s midterm duration is in line with current duration of the U.S. Aggregate Bond Index.

That means there isn’t that much more risk involved at this point with owning IEI than debt on the shorter end of the yield curve, Koyfman says.

IEI’s 30-day SEC yield is currently pegged at 0.54 percent—the SEC yield being the standardized yield calculation that reflects the interest earned in the period after expenses, iShares said on its website.

By comparison, the 30-day SEC yield on the iShares Barclays Short Treasury Bond (SHV)—with debt maturity pegged at one to 12 months—is currently pegged at 0 percent, and at 0.09 percent for the iShares Barclays 1-3 Year Treasury Bond Fund (SHY).

UST’s weighted average yield to maturity is currently 1.56 percent, according to ProShares’ website.

Trends In Flows

In terms of year-to-date flows, IEI has attracted a net of about $405 million in the first four months of the year, while SHV has seen net inflows of a whopping $1.60 billion year-to-date, bumping it to $4.18 billion in total assets. SHY, meanwhile, has bled $430 million so far this year.

In a broader perspective, IEI’s assets have been on a general upward trend since its 2007 launch, a function no doubt of the low-rate era that has favored fixed-income investments over stocks—particularly in the first few years following the market meltdown of 2008-2009. The graph above lays that bare.

The trend regarding UST flows is less readily discernible, except that they have been rather spiky since the fund was brought to market in January 2010.

The reason for that spikiness has to do with the nature of leveraged securities like UST, which, as noted, rebalance daily and thus aren’t buy-and-hold securities the way, say, IEI might be. The price of a leveraged ETF like UST can deviate quite rapidly from its underlying index, creating immediate and significant dangers to returns to users who are ignorant of this possibility.

Investors are thus likely to use UST as a tactical presence in a portfolio, putting on big trades one day and unwinding them not too long thereafter.

That’s the tale the spikes on the chart are telling, just as the immediate implication of the latest inflows is a comfort level with the Fed’s ongoing policies fostering “financial repression.”

Broadly, investors poured nearly $5.6 billion in net assets into U.S. fixed-income ETFs in April, according to data compiled by IndexUniverse.

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