ProShares launched two new Exchange Traded Funds (ETF) that short U.S. Treasuries. The ProShares Ultra 20+ Year Treasury (NYSEArca: UBT) is obviously based on the twenty year Treasury while the ProShares Ultra 7-10 Year Treasury (NYSEArca: UST) focuses on intermediate Treasuries. Both funds are structured to provide double the movement of the underlying index on a daily basis.
This is one reason why investors should tread carefully when using these products. These products are volatile and are better for traders, not long term investors. As an example of how these products work, let’s say the 20 year Treasury loses 10% of its value in 2010. This does not mean that the UBT offering will return 20% (double the loss) in 2010. It depends on what the 20 year Treasury does daily. If the 20 year rallies early in the year, the ETF could trail the benchmark considerably because the initial investment shrinks at the beginning of the year.
Day Index Return ETF Return Value
1 +1% -2% $98,000
2 +1% -2% $96,040
3 +1% -2% $94,119
4 +1% -2% $92,236
5 -4% +8% $99,615
6 -1% +2% $101,608
So the total return over this six day period was 2% (arithmetic not geometric). However, the return for the daily compounded ETF would have been 1.6%.
The other reason to tread carefully with this product is long term Treasuries may do well if we are truly in a debt deflation world. Of course, investment risk exists with all products, but the fact that everyone expects a rapid increase in bond yields raises concerns in my mind. Just look at Japan. Pundits have been calling for higher rates in the land of the Rising Sun for years.