Guest Post: TBT's Decaylicious Existence...Shown Mathematically
Submitted by QevolveQ Holdings
The investment world has been bombarded with leveraged ETF products. These products are specifically designed for use as short term trading vehicles...they are not meant to be held for long periods of time as the inherent decay factor will eat away at your principal (some levered ETF's decay faster than others, but they all decay). All too often folks write about these products without properly warning investors of the built in dangers. In this example, I'd like to mathematically show how the 2x levered short treasury ETF (TBT) stacks up over time.
Here is the mathematical breakdown on TBT's decaylicious existence...this example uses a snapshot of TLT, TBT, and long bond rates from 3 different time periods over the last 18 months (chosen specifically to show a constant long bond rate (5bps variance) versus the market price of TLT & TBT:
Note that TLT (1x long) & TBT (2x inverse) track the exact same index. Looking at the below examples, I layout the -28.9% return on TBT over an 18 month holding period with long rates & TLT virtually unchanged.
On December 28, 2009 the long bond closed at 4.70%. Prior to this, the last time the bond traded 4.70+ was June 10,2009, & in fact it closed 4.75 that day (which is 5bps better than our example, & close enough for a relative price comparison). The next most recent time the bond closed 4.70 was July 25, 2008...all 3 pricing dates for the bond, TLT, & TBT are included below:
30yr close 7/25/08 vs. 6/10/09 vs. 12/28/09: 4.70% / 4.75% / 4.70%
TLT close 7/25/08 vs. 6/10/09 vs. 12/28/09: $90.14 / $88.19 / $89.46 (notice the tiny -.68/-.75% difference in TLT over the course of 18 months @ equivalent 30yr yields...note that an estimated 23bps of this change is the expense ratio for the ETF)
TBT close 7/25/08 vs. 6/10/09 vs. 12/28/09: $71.53 / $58.77 / $50.88
At TBT's $50.88 price on 12/28/09, investors are a lot more than 5bps (in our example) from the June 10 price, in excess of approx 60bps, such as the move that happened between May 14, 09' & June 10, 09' that encompassed 67bps on the bond from 4.07 to 4.75 & a striking move in TBT from 48.94 to 58.77.
There's really no comment necessary on the 7/25/08 to 12/28/09 move in TBT...but anyone that has owned it that long, perhaps assuming flat yields over time would leave them in decent shape while maintaining the "short long bonds" exposure, has in fact lost -28.9% of their principal from by holding this instrument.
The point is, if you think long rates are going up, great....but if it takes 1 or 2 years for that to happen, you'll be grabbing your ankles for quite a while as the decay sucks away at your principal.
Anyone interested in maintaining short long bond exposure without the decay, take a look at TBF (the 1x instrument). I agree that TBT can be a great short term trading vehicle. But to sock it away in a portfolio for 1 or 2 years is just plain stupid, as the above example clearly shows.