How About This for a Hedge Combo: TBT and TLT

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Includes: TBT, TLT
by: Roger Nusbaum

From the hmm, this might be interesting file...

The chart above compares the Double Short Long Bond ETF (NYSEARCA:TBT) versus the Single Long Long Bond ETF (NYSEARCA:TLT) since TBT's inception.

I have been in the camp that thinks US interest rates are going up. This call has been wrong or early (take your pick), but I still believe it will be the case. If that turns out to be correct, then longer dated bond funds stand to get hit. As a rule of thumb an increase in rates of 100 basis points on long dated paper could be expected to cause an 8% drop in price. With individual issues you do get the par value back at the end, but with funds there is no par value that has to be made back.

With about three months of data (not a huge sample, I admit) it looks like TBT is zigging against TLT's zag. Since inception of TBT, yields have dropped a little, so TBT is down in price.

An investor putting $10,000 into TLT on May 22 (day one for TBT) and $5000 into TBT would have $14,898 at yesterday's close plus two dividends from TLT totaling $73.04. So in this example the net loss was $29 or 0.019% which is pretty good if the position really is hedged and considering that he market went against the position.

One administrative note about TBT is that it too pays a dividend, but the dividend should be annual at the end of the year and represent t-bill interest less the expense ratio. If rates do go up, including t-bill rates, then TBT would probably pay much more than it is likely to pay now.

A combo of TLT and TBT where TLT yields 6% and TBT yields 4% and the portfolio is protected from rising rates sounds pretty good to me.

Obviously the idea makes no sense at all for anyone disagreeing with the higher rate scenario. Personally I would need a little more time to be convinced the zigzag will stand up. The objective of TBT is twice the inverse on a daily basis. I think the reason it appears to be working for now is that market captured is much less volatile than equities where the leveraged products are a little less predictable.

If there is any there there, then a TLT TBT combo could be thought of as the basic strategic building block. Anyone so inclined to tinker might come up with other ways (meaning other products) to implement some sort of hedged combo. In the context of brainstorming and exploring, anything goes at this point.