typical.investor wrote: ↑
Sat Aug 25, 2018 9:46 am
JackoC wrote: ↑
Fri Aug 24, 2018 11:07 am
2. Right, the carry on the 2yr contract now is roughly +.50% on the notional amount (the note isn't really a 2 yr, the borrowing rate isn't exactly 2%, but roughly).
Sorry if this has been answered before, but does the fund get a better financing rate?
A 90/10 portfolio would earn maybe .28% (depending on exact duration) (10% * 2.81%) on the fixed income if you held them directly.
If the fund has the same carry, even leveraged up to 6X you'd only yield maybe 0.48% (again not sure on the duration and this is just a very rough estimate assuming something between 5 and 10 years).
It seems like the 90/60 has the interest rate risk, but not the yield of 60% treasuries. Not even the yield of 40% treasuries.
Or does the WisdomTree 90/60 have a more favorable financing rate?
The fund does not get a materially better financing rate. Among the plus factors for DIY futures, *if* the investor decides leverage is appropriate, is you get the same effective financing terms as institutions do*. The fund's literature suggests it might use so called 'total return swaps' in lieu of futures but there's little likelihood that comes out to a lower implicit financing rate than futures.
Of course you make less return on $200k notional using say $33.3k of your own money to support a position in one 2 yr note contract** than you make on $200k using $200k of your own money buying the 2.5% note of 6/30/20, because you're using Other People's Money, implicitly. However .50%pa on $200k is 3%pa on the capital you're actually putting up, with effective duration of around 10.8 (~1.8 duration of the 6/30/20 note times 6). Buying the 30 yr bond with $33.3k of your own money you need to go to 20.5 duration to get (slightly below) 3%. That doesn't make the leveraged position in 2yr note a free lunch of course, because you also have risk of the implicit financing rate rising and squeezing out the ~.50% spread, and for large rate rises the duration of the 30yr is much less linear than the 2yr**.
One would have to consider all aspects, according to individual risk preference, as for anything else.
*the retail investor will likely pay higher commissions for the continual trades rolling over the futures contracts, if you include that in the effective financing rate. The retail investor might or might not pay more bid-offer, it's one market basically, the fund's trades are being executed by professionals but in bigger size. The fund's commission and bid-offer cost come out of the investor's pocket separately from the ER, only the difference in those costs in the fund's favor counts against the ER. That difference is not likely to be material relative to the ER, not counting the value of the investor's time. Previously somebody responded 'that's no problem', depends on the person.
**the actual margin requirement per contract would be~ $500, but you need much more capital to cover possible losses over a long period. The fund appears to use 6:1 leverage, 90% equity uses 90% of the capital, 60% bonds the other 10%. That would require a yield on the note ~12.5% to force you out of the position, assuming no profit/loss on carry in the meantime. However assuming as a stress test the 2yr and 30yr both went immediately to their all time high monthly close yields, 16.73% and 15.19% respectively in August 1981, you'd be down ~130% (and long since thrown out of the position if you hadn't added new capital) on 6* 2yr note v ~79% on the 30 yr, due to the greater convexity (greater non-linearity of duration with rate change) of the 30 yr. A 6*2yr loss catches up with a 1*30yr loss at ~6% upward parallel shift of the yield curve. For a 1% shift the 6*2yr loses ~10%, 1*30 yr ~17%, of your $33.3k.