Do Not Invest In These Inverse Bond ETFs

|
Includes: DFVS, DLBS, DTUS, FLAT, SAGG, TAPR, TYBS, TYNS, TYO
by: Jonathan Prather

Summary

Inverse Bond ETFs can be Valuable.

Some Inverse Bond ETFs Ought to be Avoided.

Metrics for Evaluation: Expense Ratio, Liquidity, Coverage.

Do Not Invest in these Inverse Bond ETFs

I chose the worst of the worst inverse bond ETFs to avoid. If interest rates rise, as I think they will, it would be prudent to consider investing in an inverse bond ETF. However, it is important to know which inverse bond ETFs are good and which inverse bond ETFs are bad. Inverse bond ETFs perform inversely to their underlying index. The underlying index for the ETFs I will be covering include short to intermediate term treasury bonds. Particularly, these inverse bond ETFs correlate to 2/5/10/20/30 Year Treasury yields. The 10-Year Treasury Note is widely used a benchmark for interest rates. Theoretically, if interest rates rise, these inverse bond ETFs ought to produce attractive returns. I covered the inverse bond ETFs I like: the iPath U.S. Treasury 10-Year Bear ETN (NASDAQ:DTYS), the ProShares Short 7-10 Year Treasury ETF (NYSEARCA:TBX), the ProShares UltraShort 20+ Year Treasury ETF (NYSEARCA:TBT), the ProShares Short 20+ Year Treasury ETF (TBF), and the Direxion Daily 20+ Year Treasury Bear 3x Shares ETF (TMV). Now I will cover the inverse bond ETFs that should be avoided at all costs.

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. The inverse ETFs I will cover are bad in one or all three metrics. They include:

  • Direxion Daily 7-10 Year Treasury Bear 1x ETF (NYSEARCA:TYNS)
  • Direxion Daily Total Bond Market Bear 1x ETF (NYSEARCA:SAGG)
  • iPath U.S. Treasury Flattener ETN (NASDAQ:FLAT)
  • iPath U.S. Treasury 5-Year Bear ETN (NASDAQ:DFVS)
  • iPath U.S. Treasury 2-Year Bear ETN (NASDAQ:DTUS)
  • Direxion Daily 20+ Year Treasury Bear 1x ETF (NYSEARCA:TYBS)
  • Barclays Inverse U.S. Treasury Aggregate ETN (NASDAQ:TAPR)
  • iPath U.S. Treasury Long Bond Bear ETN (NASDAQ:DLBS)
  • Direxion Daily 10-Year Treasury Bear 3x Shares ETF (NYSEARCA:TYO)

Illiquid

Leveraged ETFs are already host to a long list of risks. Each of the tickers I just mentioned only have an average volume range of 700-10,000. To put that into perspective, TBT (my personal favorite) has an average volume of 3,408,570. What this mean is that each of these inverse ETFs are atrocious at reflecting actual change on a macro level because very few people are trading them. At an average volume of 1,000, each of these inverse ETFs are almost completely useless to wealthier investors. Not only would it be nearly impossible to liquidate a large amount of equity, but a large sale would actually cause a massive change in the price of the stock. An investor may even be forced to sell their shares at a discount.

High Expense

The expense ratio of an asset is the total percentage of fund assets used for administrative, management, and advertising. Essentially, it is the percentage of money an investor must pay for the pleasure of owning a security. A few of the tickers I mentioned actually have reasonable expense ratios. Highly liquid inverse bonds ETFs have expense ratios in the 0.9% range. I consider an unreasonable expense to be anything 1% or higher. However, investors should be willing to pay a higher expense ratio for more liquidity. An illiquid inverse bond ETF should have a lower expense ratio to attract more investors, so these securities ought to be judged on a different scale due to liquidity risk. For that reason, I will consider anything above .7% as an unattractive buy. The inverse bond ETFs that have an expense ratio above this level include: FLAT, DFVS, DTUS, DLBS, and worst of all TYO (at .95%).

Low Coverage

It is important for an inverse bond ETF to coverage a large range of assets. Under coverage will result in less than less than optimal correlation to the underlying index and market movement as a whole. In my opinion, a minimum acceptable basket of total assets for this class of security is 35 million. An ideal range is 1-3 Billion (such as TBF and TBT). Bad inverse bond ETFs have total assets below 35 million (this includes: TYNS, SAGG, DFVS, DTUS, TYBS, and TAPR).

Conclusion

Inverse Bond ETFs are valuable tools that should be used by financial professionals. These securities have serious risks associated with them, and it is important to choose the best tools available to achieve one's investing goals. I made this article to steer investors clear of specific inverse bond ETFs that have unneeded and undue amounts of additional risk associated with them.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.