In my opinion, the main advantage of these funds is that they offer retail and institutional investors a way to easily trade Treasury securities, which is revolutionary. Bonds are complicated, which is why many people — including hedge funds — don’t trade them. It’s much easier to buy shares of something that’s traded on an exchange and not deal with the institutional-size lots, coupon payments, and disorderly cash flow associated with fixed-income assets. Taking a single bond and putting it in an ETF solves these problems for investors. It is not hyperbole to say that the implications are enormous and that these funds have the potential to disrupt the ETF industry as well as the futures markets.
Even for the largest institutions, let alone retail investors, there is no easy way to buy a specific treasury bill or bond. Doing so would require opening an account on the government’s TreasuryDirect platform and buying odd lots of bonds directly from the Treasury Department at auction, which you would then need to hold until maturity. You can also expose yourself by buying bond futures, but then you have to deal with margin issues, basis risk (the spread between cash bonds and futures), and determining the obligation cheapest to deliver. Another option is to buy an open-ended Treasury mutual fund, but unlike an ETF, you would only have “liquidity” at the end of each day when mutual fund prices are set. day.
In recent years, the most popular way to gain exposure to the Treasury market has been the iShares 20+ Year Treasury Bond ETF. But the ETF holds a portfolio of bonds over a range of maturities, from 20 to 30 years. Thus, the characteristics of the ETF change over time, which somewhat diminishes the security and predictability aspect of owning government bonds. In other words, for all the interest in the iShares ETF, with millions of shares and hundreds of thousands of related options contracts traded, it is a portfolio whose risk is not not constant. The new 10-Year ETF is designed to track the performance of the ICE BofA Current 10-Year US Treasury Index, which simply rolls the outstanding bond from issue to issue.
Even so, these funds are unlikely to be used as a long-term investment vehicle, but rather as a trading vehicle. But as the iShares 20+ ETF has proven, having reached $25 billion in assets, being a trading vehicle can be lucrative for the issuer. The new 10-year Treasury ETF charges a fee of just 15 basis points, which is low for a “trading” ETF, but matches the fee charged by the iShares ETF. And I’m sure options related to the new ETF will be listed, which should help it steal market share from the iShares ETF and others like it. This will encourage other ETF issuers to offer similar products.
I would call this a positive financial innovation; in the world of ETFs, there is much worse. iShares bond products have gained great credibility over time, and one of their attractions is that you can trade long-term options on them, which you cannot do with bond futures. These new single bond ETFs will be one of the most successful product launches of the year.
More other writers at Bloomberg Opinion:
• Single-stock leveraged ETFs are financial mutants: Jared Dillian
• Funds Become Unexpected in Gold: David Fickling
• Commodities never belonged in your portfolio: Jonathan Levin
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Jared Dillian is the editor and publisher of Daily Dirtnap. Investment strategist at Mauldin Economics, he is the author of “All the Evil of This World”. He may have an interest in the areas he writes about.
More stories like this are available at bloomberg.com/opinion
