As the U.S. equity markets have come back strongly in 2011, many investors are growing increasingly concerned that the Federal Reserve will have to raise rates in the near future in order to combat rising commodity prices in an effort to stop inflation from wrecking havoc on the U.S. economy. Thanks to this notion, as well as concerns about the debt ceiling and mounting debt burden, some bond managers are becoming increasingly skeptical of the U.S. Treasury market. While many have voiced concerns, few warnings have commanded more attention that the one voiced recently by legendary fixed income guru Bill Gross of PIMCO. Gross, who runs the world’s largest bond fund, has been a harsh critic of U.S. fiscal and monetary policy in the months past, simultaneously pulling the fund out of a large chunk of its U.S. sovereign debt holdings.
While this move certainty attracted some attention, the King of Bonds’ latest play is sure to turn more than a few heads. According to some sources, Gross has sold off the remaining U.S. Treasury bond holdings in the fund and has now gone short U.S government debt. While the total allocation to short U.S. debt only equals 3% of the market value of the portfolio, it represents a large move in that Treasurys had made up 12% of the fund’s total assets before this latest switch. Even more noteworthy is that this bond fund now has more than 30% of its total assets in cash, suggesting that Gross is extremely bearish on the short and mid term prospects of the United States’ ability to keep interest rates subdued and bond prices elevated.
The main reasons for this switch are no secret. Gross has expressed concern with the level of unfunded liabilities. In his most recent report, he highlighted the $65 trillion in entitlement liabilities that the country will have to come up with in the near future, a staggering sum compared to the nation’s current GDP and anemic growth levels. Gross paints a dire picture for the country in the years ahead and what must happen in order to get back to some semblance of normalcy.
“The only way out of the dilemma, absent very large entitlement cuts, is to default in one (or a combination) of four ways: 1) outright via contractual abrogation – surely unthinkable, 2) surreptitiously via accelerating and unexpectedly higher inflation – likely but not significant in its impact, 3) deceptively via a declining dollar– currently taking place right in front of our noses, and 4) stealthily via policy rates and Treasury yields far below historical levels – paying savers less on their money and hoping they won’t complain.”
With comments like this, it isn’t that surprising to hear that Gross has removed all U.S. debt from the company’s flagship product in hopes of finding better values elsewhere.
While investors who agree with this thesis can always buy up shares of the Total Return Fund, there are a number of ETPs that can provide investors similar exposure without the costs of PIMCO’s fund - without the heavy cash exposure. A number of products offer leveraged short exposure to the Treasury market, and there are a handful that offer simple -100% exposure as well. Below, we highlight three possible options that could make for intriguing plays in order to short the U.S. government bond market.
ProShares Short 20+ Year Treasury (TBF)
This popular fund, which is quickly closing in on $1 billion in total assets, allows investors to short long-dated U.S. Treasury bonds. This corner of the fixed income market maintains significant duration risk, as bonds with longer time to maturity will generally exhibit greater sensitivity to interest rate changes.
iPath US Treasury 10-Year Bear Fund (DTYS)
For investors seeking -1x exposure to the middle part of the curve, DTYS is one of the few options currently available. The fund doesn’t trade nearly as often as its longer-dated counterpart but the fund does look to be a more stable play on the short side of the market while also allowing for significant gains should the market go as Gross is predicting. Like its counterparts in the space, DTYS has gained so far in 2011, posting a return of close to 4% so far.
iPath US Treasury 2-Year Bear Fund (DTUS)
For investors seeking lower levels of risk but still maintaining exposure to the short market, DTUS could make for an intriguing choice. This ETN may maintain less return potential than the options highlighted above, along with generally exhibiting lower volatility. This note has gained less than 1% so far in 2011.
Disclosure: No positions at time of writing.
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