2023-05-25 05:47:31 ET
Summary
- The ProShares Ultra 20+ Year Treasury fund is a leveraged ETF.
- The vehicle seeks daily investment results that correspond to two times (2x) the daily performance of the ICE U.S. Treasury 20+ Year Bond Index.
- Long rates have increased due to the debt ceiling debate and persistent inflation fears, but they are set to come down drastically in 2024 as per the forward curve.
- The article derives an expected return profile for UBT as compared to its unleveraged peer TLT.
Thesis
The ProShares Ultra 20+ Year Treasury fund ( UBT ) is a leveraged ETF that seeks daily investment results that correspond to two times (2x) the daily performance of the ICE U.S. Treasury 20+ Year Bond Index .
A retail investor needs to be aware of the leverage decay that is characteristic for this fund, meaning that over long periods of time leveraged ETFs' results are negatively affected by their build. These instruments are only meant to replicate the underlying index on a 1-day time horizon. The asset manager does a good job of highlighting this feature on its webpage:
This leveraged ProShares ETF seeks a return that is 2x the return of its underlying benchmark (target) for a single day, as measured from one NAV calculation to the next. Due to the compounding of daily returns, holding periods of greater than one day can result in returns that are significantly different than the target return, and ProShares' returns over periods other than one day will likely differ in amount and possibly direction from the target return for the same period. These effects may be more pronounced in funds with larger or inverse multiples and in funds with volatile benchmarks.
ProShares is a premier ETF issuer and correctly makes all the risk disclosures regarding their products, unlike some second tier managers that fail to discuss what drives the performance of their funds. That is a big positive and those are the types of things an investor should seek in a manager.
Also please be aware of the FINRA regulatory framework around leveraged products:
While such products may be useful in some sophisticated trading strategies, they are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis. Due to the effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective. Therefore, inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets.
Source: FINRA
We are going to look at UBT from the lens of a longer holding period (around 18 months) and how to use it as a capital efficient tool to access the long end of the curve or just enhance your portfolio's returns.
We believe we are close to peak rates, with the last Fed hike now behind us. While 2023 will be a rough going, the forward curve implies much lower Fed Fund rates in 2024, irrespective of the ultimate path (i.e. 2023 cut or not):
Therefore if we expect long rates to come down in 2024, we are going to explore how much of a tailwind we can expect by investing via a leveraged product such as UBT.
UBT versus TLT - What to Expect
We established above that UBT is designed to replicate via a 2x factor only the daily performance of the index or [[TLT]] in our case (an ETF which perfectly matches the index performance). Acknowledging the basis, let us look at how that tallies historically:
It looks like the fund factor, on average, comes out in the 1.7x to 2.2x range. The more interesting year for us is 2019 when the Fed cut rates the last time, and the factor ended up being 1.7x.
The TLT and Index durations are around 18 years, which put them in the 'Long-Term' bucket as per the below Vanguard table:
Duration Sensitivity (Vanguard)
Let us assume long rates will go down by 1% in the next 12 months, which would imply a rough 15% gain for TLT next year. Applying the 1.7x factor from above implies a very rough UBT move of around 25% in the next 12 months.
If we look at UBT's historical chart we can see this name is most definitely not a buy and hold instrument:
The leveraged ETF outperforms via its factor when rates move lower, and gets annihilated in a rising rates environment. It should only be bought when expectations are for rates to decrease, and it should be sold mid monetary easing cycles.
Conclusion
UBT is a leveraged ETF that seeks daily investment results that correspond to 2x the daily performance of the ICE U.S. Treasury 20+ Year Bond Index. The fund can be construed as a way to enhance a bet on long rates coming down or as a capital efficient tool (with only $100 in capital you can access $200 in exposure). When compared to TLT (an ETF which perfectly replicates the contemplated index), the fund has a historical annual factor of 1.7x to 2.2x. As discussed above the 2x replication will only apply to daily moves. In 2019 when the Fed decreased rates the UBT/TLT ratio was 1.7x. Assuming the Fed is done and long rates will decrease by 1% next year we get an implied expected return for UBT of around 25%. A retail investor who likes long bond exposure but is capital constrained, or just wants to magnify returns, should consider UBT. This fund however is not for everybody, and a target exit should be set by a retail investor. The more one holds on to this name, the higher the propensity for the slippage factor discussed in the article. We like the long end of the curve and are a Buy for UBT with an 18 month time frame in mind.
For further details see:
UBT: If You Like Long Bonds Maybe You Should Like Them 2x