Saying 'no' to Uncle Sam
ETFs that short Treasurys profit from higher yields
By John Spence, MarketWatch
BOSTON (MarketWatch) -- Leveraged exchange-traded funds that short U.S. Treasury bonds got a nice pop last week from a jump in yields, and the ETFs could see further gains if investors lose their thirst for government-backed debt.
In a dramatic sell-off Wednesday in government bonds, yields on 10-year notes surged above 3.7% at one point to their highest levels since November. That upheaval in the bond markets, which some traders said was exacerbated by mortgage-related selling, ignited fears that inflation is on the horizon as a result of the government's efforts revive the ailing financial system.
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Other forces driving interest rates higher included worries there won't be enough demand to meet massive auctions of Treasury bonds down the line, and hopes that the global economic picture may be brightening.
Nervous investors have piled into U.S. government debt during the credit crisis, sending yields to historic lows and sparking talk of a bubble in Treasury securities. Bond yields and prices move in opposite directions.
A mixture of unprecedented Treasury-bond offerings and government support to troubled financial institutions and banks "will cause the total amount of Treasurys and other government-backed debt to soar from roughly 25% of the total investment grade bond market in 2007 to 80% by 2010," according to a recent report from investment manager BlackRock Inc.
"As a result, the fixed-income market today is dominated by lower-yielding government securities, and it is our view that it will remain this way until the demand for private borrowing picks up," it added.
Bearish bond ETFs
Investors who short-sell securities are essentially betting that their prices will fall. The leveraged ETFs that short Treasurys have benefited this year as yields on 10-year notes have marched steadily higher since bottoming out around 2%. Investors hadn't seen 10-year rates that low since the 1950s.
The ProShares UltraShort Lehman 20+ Year Treasury (TBT 55.98, +3.34, +6.35%) was up 51.4% this year through May 28, according to Morningstar Inc. The ETF aims for daily performance that is twice, or 200%, of the inverse return of a long-term Treasury bond index, minus fees and expense expenses. Launched in May 2008, the ETF has an expense ratio of 0.95% and holds more than $4 billion in assets. It is among the top ETF performers in 2009.
"A lot of investors think the next bubble is in Treasurys, so this ETF can let investors take advantage of that, or hedge their bond portfolios," said Michael Sapir, chairman of the ETF's portfolio manager, ProShares, in an interview. "It's been a home run this year in terms of performance and assets."
Despite the fund's recent rally, it was hammered in late 2008 when stocks crashed while investors rushed into Treasury bonds and bid prices higher.
"Due to the compounding of daily returns, returns over periods other than one day will likely differ in amount and possibly direction from the target return for the same period," according to ProShares. "Investors should monitor holdings consistent with their strategies, as frequently as daily."
