Saturday, January 15, 2011

ETF to Watch: Treasury Ladder Fund (PLW)

The fixed income ETF space has grown considerably over the past two years, as investors worried about a slowdown in developed markets have bought up bonds despite record low yields. The first 11 months of 2010 saw cash inflows of approximately $100 billion into the ETF industry, and about $29 billion of that total went to bond products. The prices of bonds have skyrocketed in recent months on risk aversion, leading many analysts to worry a bond bubble is forming -- though these fears have somewhat calmed as equities have made a push to end 2010 on a positive note. Recent events have raised new concerns about the fixed income space, as Treasury prices fell and yields spiked to the highest level in quite some time.

From Monday to Wednesday, yields on the 10-year notes surged by 30 basis points, the largest two day run-up since the fall of the Lehman Brothers in 2008. But why the sudden spike in Treasury yields across the board, especially given ongoing worries in Europe? It seems that the general consensus is that the U.S. is not properly dealing with its budget deficit, with President Obama and the Congressional Republicans appear to be close to nearing an end to a tax-compromise deal that aims to jump-start consumer spending and growth, but at the same time increase the already massive deficit with the issuance of more debt.

This was further confirmed by a 10-year T-Bill auction that took place earlier in the week when the debt issuance failed to attract a solid number of investors. "It is extremely revealing of just how poor conditions are when we get one of the weakest 10-year auctions on record, even after the worst two day downdraft in 10-year yields since the turbulent, dark days of September 2008," said strategists at Nomura Securities. Focus will now shift to the long-term side of the market as the Treasury will issue 30-year bonds. Hopefully these notes will be better received than their shorter-term counterparts, but there is a fair amount of skepticism.

The 30-year auction will be closely followed today, putting all funds in the Treasury Bonds ETFdb Category in focus. In addition to dozens of funds honing in on various stretches of the maturity curve, there are a few ETFs that spread exposure throughout the Treasury market, including the PowerShares 1-30 Treasury Ladder Portfolio (NYSE: PLW). This fund follows the Ryan/Mergent 1-30 Year Treasury Laddered Index, which measures the potential returns of the U.S. Treasury yield curve based on approximately 30 equally weighted U.S. Treasury issues with fixed coupons, scheduled to mature in a proportional, annual laddered structure. If today's bond auction attracts a low level of demand, prices may take yet another hit, sending this fund down. But if the auction goes well and the recent sell-offs in Treasuries attract opportunistic buyers, the Treasury bond space could be due for a bounceback on Thursday.

Disclosure I am long PLW shares and have been for quite some time.

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