Using ETPs to Better Understand and Monitor the Bond MarketsMarch 6th, 2013 by Kurt Shrout
You can use ETPs (exchange-traded products) to better understand, and monitor the performance of and sentiment in, the bond markets. This is not the only mechanism I use to monitor the performance of and sentiment in the bond markets, but it is a very useful one. In my Merrill Edge MarketPro tool, among many other things, I maintain a list of bond ETPs for which I can track price changes on an intraday basis.
To see a list of high yielding CDs go here.
I usually review this list after each trading day to see how various types of Treasury, municipal, corporate, etc. bonds performed that day. Sometimes, I look at price charts for the ETPs to see the price performance of the products over time. Other times, I compare the prices of the ETPs to their NAVs (net asset values), looking for larger price premiums or discounts to NAV that reflect sentiment in the marketplace that goes beyond that which is reflected in the prices of the underlying bonds.
For many investors, it is difficult to get a comprehensive, detailed, all-in-one view of the bond markets. From a price movement versus an interest rate perspective, creating a ETPs tracking mechanism addresses this problem. In creating such a mechanism, there are many factors. The most important thing is to find index ETPs that trade sufficiently often―preferably very often―and well-represent the classes of bonds you are interested in. Low-expense-ratio products are best to get a better view of price performance over longer periods of time; however, many ETPs do not have a long history.
Below, in a chart, are some of the ETPs in my bond ETPs tracking mechanism. This set of ETPs provides a good overview of the U.S. bond markets. I do not recommend that you purchase any of these ETPs. Although some of these ETPs hold at least some bonds to maturity or close to it, they all, except for BAB (PowerShares Build America Bond Portfolio), purchase longer-to-maturity bonds to replace matured or sold bonds, thereby maintaining a somewhat stable weighted-average maturity. These ETPs, except for BAB, will experience a significant loss in share price when interest rates rise.
The Build America Bonds program only existed in 2009-2010. The bonds in BAB are a legacy of the program. The Build America Bonds program may be reestablished, thereby creating the same somewhat-stable-weighted-average-maturity characteristic in BAB that the other ETPs in the chart below have.
The share price movements of the ETPs in the chart below reflect the price movements of the set of bonds, notes, and/or other securities that the ETPs hold. The Approximate Years to Maturity data in the chart reflects the actual current holdings of each ETP, versus what each ETP is designed to hold. For example, TLT (iShares 20+ Year Treasury Bond ETF) currently holds bonds with about 26 to 30 years remaining to maturity; so 26-30 is listed in the Approximate Years to Maturity column for TLT.
Some types of bonds are often callable or the like. Callable means the borrower can mature the bonds prior to their stated maturity date. There is a Significant Number Callable? column in the chart so you can see what types of bonds significantly tend to be callable. Also, YTM (yield to maturity) and YTW (yield to worst) data is provided; so you can see the no-change-in-interest-rates theoretical impact of some of the bonds being callable on the ETP yield. YTW considers the fact that some bonds can be called. YTM does not. The YTM and YTW figures are as of 1/31/13 to 3/1/13, varying by ETP provider.
The Approximate Years to Maturity and Weighted Average Maturity figures shown are deceptive if the ETP holds a significant number of bonds that are callable. These figures assume that none of the bonds will be called. YTM and YTW do not account for expense ratio. Expense ratios are shown in the chart. The non-weighted-average expense ratio for the ETPs in the chart is 0.22%.
There is a lot of inaccurate information regarding ETP premiums and discounts on the Internet. For example, when using Morningstar one night, I noticed that, for the same ETP, it was showing me a premium one time and a discount to the same degree as the premium previously shown the next time. This occurred for every ETP I looked at. I derived the Premium or Discount data in the chart below by looking up the ETP’s NAV on the ETP provider’s website; and, then, I obtained the associated share price of the ETP elsewhere. The Premium or Discount data is as of 2/28/13 or 3/1/13, varying by ETP provider.
Bond ETPs have been tending to trade at a premium. The non-weighted-average premium or discount for the ETPs in the chart below is a 0.12% premium. The large premium at which VCLT is currently trading is not very unusual for a higher-yielding bond ETP. It seems there is a yield-chasing effect generally reflected in the premiums or discounts associated with bond ETPs. Also, it seems traders like to use some of the high-years-to-maturity ETPs to bet on the direction of interest rates, while simultaneously benefitting from the relatively high yields of these ETPs. When interest rates were rising late last year and earlier this year, VCLT often traded at a discount.
|ETP||Approx. Yrs. to Maturity||Wt.’ed Avg. Maturity||Significant Number Callable?||YTM||YTW||Expense Ratio||Premium or Discount|
|Treasuries – STRIPS|
|Treasury Inflation-Protected Securities (TIPS)|
|Mortgage-Backed Securities (MBSs)|
|Municipal Bonds – AAA-to-A-Rated (See Notes)|
|Municipal Bonds – BBB-and-Lower|
|Municipal Build America Bonds – Investment-Grade, Interest Taxable|
|Corporate Bonds – Investment-Grade|
|Corporate Bonds – Junk|
|Corporate Senior (Leveraged) Loans – Many Floating Rate, Very Largely Junk|
|Corporate Floating Rate Notes – Investment-Grade|
EDV: STRIPS stands for Separate Trading of Registered Interest and Principal of Securities. STRIPS are individual interest and principal payments that have been split into separate, zero-coupon securities. The principal payment is one security, and each interest payment is another security. EDV covers Treasury (non-TIPS) STRIPS. The trading volume for EDV is low, but there is not a better ETP covering the STRIPS space.
VTIP, TDTF, TIP, and LTPZ: YTM can only be estimated because it depends on the future rate of inflation.
LTPZ: The trading volume for LTPZ is low, but there is not another ETP covering the long-term TIPS space. The Weighted Average Maturity was derived using data on the PIMCO LTPZ “View all holdings” webpage.
AGZ: Many of the bonds held by AGZ are Fannie Mae, Freddie Mac, and Federal Home Loan Bank securities.
MBB: Covers the breadth of the Ginnie Mae, Fannie Mae, and Freddie Mac residential mortgage-backed securities (RMBSs) market. The Weighted Average Maturity and YTM were derived using data on the iShares MBB Holdings webpage. Principal on the loans within the RMBSs is paid back over the life of the loans, and residents move sometimes, thereby ending their loans early; so the Approximate Years to Maturity and Weighted Average Maturity numbers are deceptively high. RMBSs have prepayment risk and extension risk, each of which lessens the value of RMBSs.
CMBS: Covers the ERISA-eligible commercial mortgage-backed securities (CMBSs) market. ERISA stands for Employee Retirement Income Security Act. The trading volume for CMBS is very low, but there is not another ETP covering the CMBSs space. The Weighted Average Maturity and YTM were derived using data on the iShares CMBS Holdings webpage. Principal on the loans within the CMBSs is paid back over the life of the loans, so the Approximate Years to Maturity and Weighted Average Maturity numbers are deceptively high.
SHM: The bonds held by SHM are almost entirely rated AAA or AA.
ITM: The bonds held by ITM are almost entirely rated AAA, AA, or A.
TFI: The bonds held by TFI are almost entirely rated AAA or AA.
PZA: The bonds held by PZA are almost entirely rated AA or A.