Negative duration bond ETFs

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ghariton
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Negative duration bond ETFs

Post by ghariton » 30 Nov 2016 10:00

I learn something every day. Apparently there are two negative duration bond ETFs in the U.S. market. One has a duration of negative 5, the other negative 7.

Administrative fees are reasonable. For example, the lower cost ETF (AGND) has a MER of 0.28% and an average spread of 0.55%. The second one (HYND) has a MER of 0.48% and an average spread of 1.71%.

Each fund is long traditional bonds and is short Treasury futures. The result increases in value as interest rates rise (and of course decreases in value as interest rates fall).

Is this a worthwhile hedge against rising interest rates?

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Re: Negative duration bond ETFs

Post by 8Toretirement » 30 Nov 2016 11:34

Interesting concept but I am not into derivatives as an investment product personally.

I am comfortable with 1-5 year laddered Government bonds with duration just shy of 3 years currently, but about 2.5yr duration when I bought them. Also have a 0.5 duration ultra short bond ETF with minimum volatility, maybe 0.10% movement either way, very stable.

I hold bonds for a small bump in the yearly return but mostly for safety.

3 years to break even works for me to get the safety component.

Equity component should capture some gains from a US interest rate rise as economic factors should increase all things being equal.

I am happy if my return can double rate of inflation each year. I don't have lofty goals, over time I realized I am a better saver than investor. We save more than enough to meet and surpass our retirement goals.

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Re: Negative duration bond ETFs

Post by longinvest » 30 Nov 2016 12:52

Negative nominal yields were already a new thing for me a while ago. But, negative duration?!

Help me understand. Does this means that when I had a mortgage, I was effectively holding a negative duration bond? How does that work?

I'm lazy; I haven't read the linked article.
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newguy
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Re: Negative duration bond ETFs

Post by newguy » 30 Nov 2016 13:23

It sounds to me like you just trading the IG or HY spread. We can look at that history and compare it. Let's try python this time.

Code: Select all

import pandas_datareader.data as web
import datetime

start = datetime.datetime(1996,12,31)# earliest for spread data
hy_sprd = web.DataReader("BAMLH0A0HYM2", "fred",start)
hynd = web.DataReader("hynd", "yahoo")

#just get needed columns and dates combined
combined = pd.concat([hy_sprd.BAMLH0A0HYM2, hynd.Close], axis=1, join='inner')

# the cumulative percentage change
pct_chg = combined.pct_change().cumsum()

# invert and re-scale just for easy graph
pct_chg['hy_sprd_inv'] = -pct_chg.BAMLH0A0HYM2 / 3

import matplotlib
%matplotlib inline
pct_chg.loc[:,['hy_sprd_inv', 'Close']].plot()
hynd.png
hynd.png (26.22 KiB) Viewed 727 times
Looks pretty similar, note I just guessed at some scaling to fit them in the graph easily. So if that's what you're thinking of buying, you can just look at the history of the high yield spread and get some idea of how it will perform in a market cycle when HY is crashing.

Here it is inverted since it's in yield

Code: Select all

hy_sprd.plot().invert_yaxis()
inv.png
inv.png (14.09 KiB) Viewed 727 times
You can add a little arrow at the end saying "you are here"

newguy

add: The spread data is option adjusted. Since the HY bonds often have embedded options the spread data need to reflect this. I don't know how efficient the ETF pricing is in this respect. Certainly other products don't always consider possible future yield changes.

also, HYND pays a 4.7% ttm yield which I ignored.

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Re: Negative duration bond ETFs

Post by IdOp » 01 Dec 2016 10:45

I'm tentatively quite skeptical of these negative duration ETFs, but I'm not fully clear on what they own. The linked article says they are "short Treasury futures". Does this refer to Treasury Bills (rather than Bonds)? IOW, is that like having a short position in very short term bonds (T-Bills) ?

[ADDED: On second thought, unqualified use of "Treasuries" probably means Treasury bonds. If that's the case I should change my skepticism to neutrality based on lack of understanding how shorting Treasury futures works.]

It seems to me though that you don't need negative duration to make money from rising interest rates. You just need to short a bond, and that has positive duration. You'd make money because the price is negative and gets less negative.

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Re: Negative duration bond ETFs

Post by adrian2 » 01 Dec 2016 20:06

IdOp wrote:It seems to me though that you don't need negative duration to make money from rising interest rates. You just need to short a bond, and that has positive duration. You'd make money because the price is negative and gets less negative.
It seems to me though that you don't need negative duration to make money from rising interest rates. You just need to buy something like Manulife, which I've been calling for years as the "anti-long bond company".
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Re: Negative duration bond ETFs

Post by IdOp » 01 Dec 2016 22:28

adrian2 wrote:You just need to buy something like Manulife, which I've been calling for years as the "anti-long bond company".
Yes and thank you BTW for those previous observations, as they helped me decide to buy a bit of MFC about a year ago. Timing was not great as it went down quite a bit, but now is up 10%.

Or one could buy HISA/T-Bills/Short bonds and wait patiently.

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Re: Negative duration bond ETFs

Post by 8Toretirement » 02 Dec 2016 11:47

IdOp wrote:I'm tentatively quite skeptical of these negative duration ETFs, but I'm not fully clear on what they own. The linked article says they are "short Treasury futures". Does this refer to Treasury Bills (rather than Bonds)? IOW, is that like having a short position in very short term bonds (T-Bills) ?

[ADDED: On second thought, unqualified use of "Treasuries" probably means Treasury bonds. If that's the case I should change my skepticism to neutrality based on lack of understanding how shorting Treasury futures works.]

It seems to me though that you don't need negative duration to make money from rising interest rates. You just need to short a bond, and that has positive duration. You'd make money because the price is negative and gets less negative.
My thoughts, If we can't work out the full details of how the fund is structured and I would opinion that non of us know the full details of this funds use of derivatives, then we should give pause to purchase.

FI = Safety. When we start to use complicated derivatives in the search for higher yields we lose the safety provided by FI.

Is the potential for extra yield worth the loss of safety?

Might be better to tilt the equity portion slightly to gain a lift in the portfolio on interest rate rises than corrupt the bond side with derivatives.

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Re: Negative duration bond ETFs

Post by queerasmoi » 05 Dec 2016 20:28

Heh, in theory, if you wanted to short a bond ETF, you should make sure you find the one with the highest MER possible to ensure it goes down more than it otherwise would ;)

I think a "high" interest savings account is probably a better bet than a derivative-based negative-duration bond fund.

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Re: Negative duration bond ETFs

Post by AnonymouslyInvesting » 16 Dec 2016 21:02

Be careful of those simple 1-5 year passive bond ETFs, like CBO. They have good yields, but in this interest rate environment to get yields that high with such low maturities, they have to buy bonds far above par. When you factor in the natural depreciation as the underlying bonds approach par, the net return is lower than 2 year GIC yields.

Floating rate ETFs can be an interesting way to hedge some interest rate risk. I personally like HFR. It's up over the past few weeks. Otherwise, buying individual bonds in a yearly ladder based on YTM is a good passive bet.
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Re: Negative duration bond ETFs

Post by adrian2 » 17 Dec 2016 11:32

AnonymouslyInvesting wrote:Be careful of those simple 1-5 year passive bond ETFs, like CBO. They have good yields, but in this interest rate environment to get yields that high with such low maturities, they have to buy bonds far above par. When you factor in the natural depreciation as the underlying bonds approach par, the net return is lower than 2 year GIC yields.
I would be careful before stating generalizations that may appear clear cut, like the above.

Have you taken the quiz in this thread: Bond investing?
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