New Bond ETFs: Bet On Inflation*, Lower Your Costs, Or Earn Higher Yield

Part 1 of 4 On Bond ETFs

  • New ETFs By iShares Enable You To Bet On Inflation
  • New ETFs By iShares Let You Earn Higher Yield Without Investing In Junk
  • New ETF by PIMCO Lets You You Save on Fees

ETFs That Let You Gamble On Inflation

Do you have a view  on inflation?

If you think inflation is going to be lower than 1.9% or South of 2.3% per year for the next few years, then you might be interested in the iShares UltraPro 10 Year TIPS/TSY Spread (UINF) and the UltraPro Short 10 Year TIPS/TSY Spread (SINF)*.

SINF allows you to profit if inflation rises at a pace in line with the market’s expectations. The ETF buys the 10 year maturity TIPS (Treasury Inflation Protected Security) and simultaneously shorts the 10 year treasury. The Price of the TIPS rises or falls in value with inflation, as measured by CPI (Consumer Price Index).  The TIPS price also changes with the current yield of the 10 year treasury. By simultaneously shorting the 10 year treasury and buying the 10 Year TIPS, iShares has created an ETF which is a pure bet on inflation*.

*The problem with the fund however is that it is a “leveraged ETF” meaning the fund is designed to amplify the gain or loss by 3X’s.  We could argue that the use of leverage is good or bad depending on the situation, however it is not the leverage used by the ETF that we have a problem with.  The problem with leveraged ETF’s is that they are designed to track the underlying investment FOR 1 DAY ONLY.  The longer one holds a leveraged ETF, and the more volatile the underlying investment is during that time, the further away from reality the investors expected gain or loss on the leveraged ETF will be.  You can read more about this problem here.

Earn Extra Yield While Investing In Investment Grade Bonds.

Investment Grade bonds are considered much safer than Junk bonds. Historically their default rate is a tiny fraction of junk bonds. Generally speaking, a bond’s rating determines how much interest you can earn. BBB bond will earn a less interest than a AAA bond. In theory, according those that rate the bonds (like S&P and Moodys), all BBB should have the same rate of default.

The market does not always agree.

As we discuss in our article “Are Bank Bonds Cheap?“, the market thinks that bonds of financial companies are more risky than the bonds of industrial companies, and therefore requires that they pay more yield. A bond of a financial company can pay one, two, or three percent more than a similar rated non-financial bond. iShare’s Financial Sector Bond Fund (MONY) lets you invest in these investment grade financial bonds. Holdings include bonds of companies like Citigroung ( C) and Bank of America (BAC).  MONY is not a leveraged ETF, so you avoid the problems we explained above when talking about inflation based ETFs.

PIMCO launches an ETF Version of The Total Return Fund.

The Total Return Fund, which manages over $250 Billion dollars, is now available as an ETF. As explained below there as some differences which will, according to PIMCO, make the performance of the mutual fund and the ETF slightly different.  These difference are:

  1. The ETF cannot use derivatives like interest rates futures and
  2. The ETF is starting from scratch, so certain bond inventory currently in the mutual fund may not be available for purchase right now. As a result, while types of holdings will be the same the individual bonds will be different.

The biggest difference however is fees, which will be one of the topics in our next article in this series “Three Arguments against Investing in the PIMCO Total Return Fund ETF (TRXT)“.

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