In the past, investors looking for excitement probably weren’t going to find it in the bond market – unless they were trading futures and options on the exchange. However, today anyone can get a better chance of their investment dollar through leveraged bond funds or exchange-traded products (ETPs) or exchange-traded funds (ETFs). This article also applies the leveraged bond funds statements to leveraged ETFs.
The relationship between investment risk and reward
As is usually the case with all investments, the potential to attract more rewards brings with it additional risk. As the name suggests, debt bond funds are funds that use their earnings, using borrowed money and/or derivatives to multiply investments. For example, triple-leveraged bond funds with $ 100 million in assets from its investors could borrow another $ 200 million against equity capital and use that borrowed funds to buy additional bonds on behalf of its investors, tripling their profits as well as their losses.
As another example, consider whether US Treasuries return 1%, triple (or 3x) stock Treasury returns 3%. Likewise, a 3% decrease in the value of a bond in a 3% fixed rate bond fund gives a 9% loss.
For an example of the inherent risk and volatility of use, consider the action in the Treasury ETF ProShares Ultra 20+ Years (ticker: UBT) in the fall of 2011.
From the closing price of $ 105. August 25 August 31, the fund grew to $ 140. 52 by Oct 3 and then dropped to $ 111. 38 October 27 – 20.7% loss in just 18 trading days. Before buying a leveraged bond product, assess your risk tolerance to make sure you can withstand this type of volatility.
Reverse bond funds
The mentioned leveraged bond funds are not the only option for fixed income investors.
There are also reverse bond exchange products (ETPs) that are bet against the market. Some of these ETPs are 2x and 3x leveraged, except that they reverse the direction of leveraged bonds and imply an opportunity for investors to profit from higher bond rates. However, they pose the same risks as other leveraged bonds.
Are investors misunderstanding bond funds?
Whatever the authentic purpose of the leveraged finances, it has sometimes been argued that they have been simplest designed for quick-time period trading strategies through sophisticated investors – they have turn out to be extremely popular with retail investors who sometimes hold them as long-term, long-term investments.
The trend in bond funds towards the use and concomitant use of derivatives to total returns alarmed the International Monetary Fund (IMF), which issued a position paper on the growing danger in early 2016. ”That use leverage. A growing number of supposedly flat bond funds also use derivatives. This practice, the IMF noted, poses a hidden risk for ordinary investors.
Investors should also be aware that double and triple borrowed funds provide the expected performance on individual days.
Over time, the compounding effect means that investors will not see the performance that is exactly two or three times that of the underlying bonds. In fact, the longer the time period, the greater the discrepancy between actual and expected returns. This is another important reason why borrowed funds should not be considered a long-term investment.
Money does no longer provide tax, investment, or monetary offerings and recommendation. The information is presented without regard to the investment objectives, risk tolerance, or financial circumstances of any particular investor and may not be appropriate for all investors. Past performance is not indicative of future performance. Investing involves risk, including the potential loss of a principal.
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