Leveraged Treasury ETFs for a bet on a FED reversal

The treasury bond market is thought to be one of the safest publicly traded investments available to investors. Fully backed by the United States Treasury, it has become synonymous with a flight to safety during times of uncertainty and often has a negative correlation to equity markets, particularly indexes with a heavy tech exposure.  
Unfortunately, as investors have been painfully made aware this year, this inverse relationship seems to have stopped, as a result of the unprecedented rate of interest hikes in 2022. Not only has the relationship between Index ETFs like the TLT and QQQ become heavily correlated over the last year, the TLT has lost more value than the tech-heavy QQQ, with YTD performances of -33% and -31% respectively! This truly has been a perfect storm for all asset classes, even those that traditionally acted as safe havens.
Although far from certain, whispers have been growing that the FED is quickly approaching its terminal interest rate. Leaked internal discussions between prominent members of the voting committee were released in the final week of October, and further emboldened risk-on investors. The rumors proved to be at least partially correct, with the FED raising rates by an expected 75bps on Nov 2nd and giving the slightest hints of a dovish tilt in their messaging. Although the timeline for this eventual “pivot” is anything but certain, the FED’s massaging was clear; we are close to the end of the hiking cycle. 
As such, investors should be mindful of the effects of a halt in rate hikes on treasuries and may wish to consider exposure to ETFs that will take advantage of this coming reality. 

To Leverage or not to Leverage

The concept of a leveraged ETF can seem complicated at first, and there is no doubt the mechanics of it can be quite complex. But the main idea is quite simple; a leveraged ETF uses leverage in the form of borrowed funds or derivative products, to achieve multiples of the performance of a tracked index. 
There are, of course, inherent risks with such products, such as rollover risk from the derivatives, or the fact that leverage also increases losses in the event of a continued downtrend. These are just a few of the more common risks associated with a leveraged ETF. 

However, there are also benefits with a Leveraged Treasury ETF, worth considering by sophisticated investors. A Leveraged ETF allows investors to gain a target level of exposure to Treasuries for less cash. If the target level is 10% in their portfolios, they are able to achieve this with only half the cash expenditure since the ETF is designed to magnify returns by 2x. This frees up cash for allocation to other areas of the portfolio. It also allows for overweighting a market segment without the need for additional cash. This feature could be of interest to professional asset managers, in their goal to earn Alpha in a given fund or portfolio.

Gaining Exposure

For investors wishing to gain exposure to any upcoming rally in Treasuries resulting from a FED halt or pivot, there are certainly options for them to consider. One such example is the ProShares Ultra 20+ Treasury ETF (UBT), which aims to provide 2x the daily performance of the +20-year Treasury bond Index. The ETF is down 56.28% YTD, which is 2x the performance of the TLT of -33%, illustrating the fact that leverage, unfortunately, magnifies losses as well as gains. A rebound in the TLT would however see 2x the increase in the UBT. 

A second choice for investors could be the Simplify Risk Parity Treasury ETF (TYA), which also seeks to track the +20-year Treasury Bond Index but does this by allocating capital to intermediate-duration Treasuries, rather than long-dated treasuries. This allows for less volatility in the returns relative to the UBT, which primarily invests in treasuries dated +20 years
It is important for investors to realize the different objectives of these two ETFs. The UBT is designed to provide 2x the daily return of the index, while the TYA seeks to match or outperform the index on a quarterly basis. This means that their respective strategies are not designed to perform in line with expectations past their daily or quarterly goals, which could result in significant over / underperformance relative to the index if held past their stated timeframes.

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