Scalper1 News
Summary TYO has a high expense ratio. It is illiquid. The ETF is too volatile and does not adequately cover its underlying market. Introduction I have written a number of articles about my favorite inverse bond ETFs. I have also compiled a comprehensive list of the inverse bond ETFs I hate the most. I have discussed these securities extensively over the past few weeks, because I believe we are in an economic environment unavoidably poised to experience rising interest rates. Inverse bond ETFs can be used shrewdly to capitalize on this market inevitability, and they are valuable hedging tools for bond-heavy portfolios. However, there is long list of risks associated with investing in an inverse bond ETF, and it is prudent to research and analyze each security before investing. For this reason, I decided to write an article about the single worst inverse bond ETF on the market, the Direxion Daily 10-Year Treasury Bear 3X Shares ETF (NYSEARCA: TYO ). What Makes an Inverse Bond ETF Bad? When evaluating an inverse bond ETF, it is important for an investor to find a security that has a low expense ratio and correlates well to its underlying index. The three most important metrics for determining the quality of an inverse bond ETF are liquidity, expense, and coverage. A good inverse bond ETF has a low expense ratio, is highly traded, and maintains assets with wide coverage. A bad inverse bond ETF does just the opposite. Another metric that ought to be considered is the strength of the underlying institution that issues the inverse bond ETF. If the institution cannot honor an investment, an investor stands to lose everything. Another factor that ought to be considered is the inverse bond ETFs’ leverage multiple. Inverse Bond ETFs come in three sizes: 1X, 2X and 3X . 2X and 3X ETFs are designed to multiply the returns (or inverse returns) of the daily performance of an underlying index. 1X ETFs follow the daily returns of its underlying index one for one. Since 3X inverse bond ETFs track daily returns by three times, the risks already associated with inverse bond ETFs are exacerbated exponentially. Compounding risk greatly affects the returns of 3X ETFs particularly when tracking range-bound indexes. To read more about the risks of 2X and 3X leveraged ETFs, read my article here . TYO Analysis TYO is the worst inverse bond ETF because its expense ratio is high, it is not highly traded, it does not have wide coverage, and it is triple leveraged (which magnifies the risks associated with investing in it particularly for periods longer than one day). TYO is really the only option for 3X exposure to intermediate-term US Treasury bonds, however, just because it is the only option, does not mean it is a good option. It is the responsibility of issuing institutions to produce a good product that creates its own demand. TYO simply fails in all regards. I included a graph as more of a visual aid to show how TYO works. TYO Performance I included a graph mainly to show how TYO performs relative to its underlying index. The Direxion Daily 10-Year Treasury Bull 3X Shares ETF (NYSEARCA: TYD ) (green) is the 3X bull for 7-10 year Treasury bonds and TYO (orange) is the bear. I also included 10-year Treasury yields to show the correlation between bonds, yields and inverse bond ETFs. From a broad perspective, TYO is well correlated to 10-year yields and provides the results an investor would hope and expect from its underlying index TYD (about .99% correlation). TYO Analysis Continued On the surface, TYO seems to perform the job it is meant to perform. To see how TYO fails, one must examine the security closely. First, TYO’s net expense ratio is very high. The industry average for much more respected and liquid inverse bond ETFs is about 0.9%. Based on TYO’s total assets however, its average competitor has a net expense ratio of about 0.7%. TYO itself boasts one of the highest net expense ratios at 0.95% . What this means is, the investor must pay 0.95% just to hold TYO. The biggest risk of holding TYO, however, is its liquidity risk. It has an average volume of 10,228. TYO’s price is 18.15*10,228=$189,320. Basically, the ETF is off limits to any wealthier investors or money managing firms. Those who hold TYO run the risk of not being able to sell when they want, or causing a drop off in price when attempting to sell large volumes. Either way it’s a huge risk that can be avoided by investing in a more liquid inverse bond ETF. Lastly, TYO only has 49 million in total assets. It does not have an adequate amount of market exposure to fully correlate to changing market conditions. Conclusion The market speaks loudly and prices drive demand. An overpriced inversely leveraged ETF like TYO is going to have very little volume because investors do not want the risk. It is 3X leveraged, so it is designed to be inherently volatile. I can only imagine a poor investor losing money and being unable to sell their shares because no one is buying (or selling). Pick a better, more liquid ETF like the ProShares UltraShort 20+ Year Treasury ETF (NYSEARCA: TBT ) if you are trying to utilize an inversely leveraged ETF. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Scalper1 News
Scalper1 News