On The Mechanics Of Pimco's Synthetic Treasury Short, And How The Firm Extracted 9,724 Years Of Duration Out Of Cash

Tyler Durden's picture

And now a little follow up into Pimco's TRF holdings and real risk exposure. In addition to the previously noted Pimco holdings in Euro$ position (delayed, as the fund does not disclose actual holdings on a monthly basis), below we present the fund's positions that contribute to a substantial negative dollar duration position, primarily contained in various swaps and swaptions. Whereas the fund's euro$ positions are primarily to hedge rate bets in the future, they do add to the fund's dollar duration, and for practical purposes would not lead to a negative DWE number in the TRF. The contributors to negative duration can actually be found in PIMCOs various synthetic holdings, primarily of the swap and swaption variety as seen on the chart below, which however is as of June 30. Since then the dollar duration equivalent of the TRF has plunged which certainly means that PIMCO, while perfectly allowed to do as it wishes with cash, has loaded the boat on swaps and swaptions. Lastly, since PIMCO is likely betting on a massive curve steepening move, this alone means that whether expressed in a  DV01 or carry neutral basis, the firm may have a positive MW exposure while being substantially negative duration and thus risk exposure. One can think of it as two massive offsetting synthetic hedges: the euro$ leg on one side adding duration and the swaption/swap leg on the other, both of which are the true determinants of PIMCO's risk exposure and rate bet. What happens in the cash side is irrelevant: PIMCO can parade that it does not have one cash Treasury short, which would be technically correct, yet be massively short bonds. A comparison could be made to Goldman's declaration to clients that John Paulson was long teh equity tranche of Abacus. Yes, but he was also massively short everything above the equity. And the firm's misrepresentation of this nuance is what the entire legal case against it was based on. We doubt PIMCO will suffer a comparable indignity, however (perhaps at most one or two LPs pulling their capital).

And another curious, if unrelated tidbit, which goes to the firm's efficient (to say the least) use of cash collateral (and exogenous risk exposure). As the chart below shows, as of June 30, 2010, Gross held $234 billion in Euro$ futures and $59.2 billion in long Treasury futures (combined accounting for 125% of the market value of the fund). Yet where it gets tricky is that while factoring for dollar duration on these two futures, and getting a number of $281.7 billion, the collateral pledged against this total number in futures was $28.95 million, or a whopping 9,729.4 years in cash duration.

We have seen how margin hikes impact commodities, whether under the influence of an administration gearing to combat speculators or otherwise. So what would happen if one of those hundreds of IRO contracts up there saw its margin hike? Simply said: PIMCO may find itself in a slight liquidity crisis, especially if the validity of nearly 10,000 years in cash duration is every questioned (by the appropriate authorities). And what is certain is that PIMCO knows this... yet continues to antagonize the administration with Bill Gross' monthly missives which were the inspiration for the Chairsatan moniker, and repeated allegations that the US is a ponzi scheme...

Simply said, something about this very unpleasant worst case risk/return arrangement, or rather the willingness of Pimco to expose itself to this "risk", is rather odd.

h/t J.P. Jr