long bond through futures (long term position)

L

luisHK

Hi

I think I've got a grasp on how equity futures work but not so much on treasury futures, especially that the underlying is not as clear with bond futures.
Can one use ZN and ZB as proxies for IEF and TLT, or simply as a proxy for the underlying bonds, in a buy and hold portfolio the way one could use ES in lieu of SPY?
Are the bonds/notes interest payments incorporated in the futures price so while holding those futures long one will benefit from those payments ?

Also what other bond futures can one use to incorporate in a long term portfolio (I'm long equities in Europe and Asia as well) ?

Thanks in advance for all related input
Luis
 
luisHK said:
Hi

I think I've got a grasp on how equity futures work but not so much on treasury futures, especially that the underlying is not as clear with bond futures.
Can one use ZN and ZB as proxies for IEF and TLT, or simply as a proxy for the underlying bonds, in a buy and hold portfolio the way one could use ES in lieu of SPY?
Are the bonds/notes interest payments incorporated in the futures price so while holding those futures long one will benefit from those payments ?

Also what other bond futures can one use to incorporate in a long term portfolio (I'm long equities in Europe and Asia as well) ?

Thanks in advance for all related input
Luis
More...
there's really no value in futures over cash, they come out about the same. It's generally considered that long term cash is cheaper but not noticable unless you are dealing with large sums. Yes, zn and zb are proxies for any etf with the same maturity. If by long term you mean a year or more I would use the cash market.
 
I'm no expert but I believe the futures have a drag on returns that reflect libor financing. This happens because you get exposure to the bonds putting no money down. You need margin collateral, but since you can buy UST bonds (earning interest) and then use them as collateral to be long futures (earning a syntethic interest), the futures get pushed up to a point where their returns reflect that financing advantage.

Over the last few years that financing was super cheap (with libor at 25-17bps) now that libor is higher (3m is at 0.62%, 1m 0.43%) this drag is more significant. That's why guys like Gundlach are bitching about the Fed tightening cycle, it ruins a lot of the leverage and carry strategies that were so good for so long

If anyone thinks this is wrong, let me know.
 
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If the Fed hikes rates more it might get to a point where the drag will be more than the yield and it will be uneconomical to hold and rollover them as an investment (though,they will still be great leverage vehicles). What one can do to offset that is to increase the duration of the cash bonds that you do hold
example:
you have 50% in cash bonds and 50% in futures. You sell the futures because libor is too high, you can them now buy longer-term bonds in the cash bonds portion to offset the drop in duration and yield that the futures caused. The overall situation will still be very similar. It might even be superior because there will be no libor drag in the returns
There are some differences because the relationship between different points of the curve might change but if you are a long-term holder, I think it will still be similar
 
Thanks both for your replies, it seems I got the products right but let me know if I'm erring below.

Cash market seems better than futures generally because there is no financing costs - if the products are bought cash though, any margin financing through the broker would be more expensive than the financing rate embedded in the futures.

Daal, about the part below :

"If the Fed hikes rates more it might get to a point where the drag will be more than the yield "

When fed hikes rates, the yield is supposed to go up as much as the financing cost, isn't it ?

A way to get back this financing costs might be to sell 1 month out atm put on liquid contracts, like ZN and ZB, if it works similarly to SPX or ES, there should be a slight edge in the long term over buying the futures outright, although if one is long equities at the same time, the overall portfolio might react more brutally than one wished at times of stress (ie equities crash and bond rallies, but the short term profit on short bond futures puts is much lower than what the profits on long bond futures would have been, while the equity portion of the portfolio takes a large hit)

I’d be keen on buying diversified bond ETFs like BND, but the 30% withholding tax on dividends (trading through an offshore entity) hurts the returns, anyone has advice on liquid bond ETFs in jurisdictions without withholding tax on dividend payments, like HK or Singapore. The USD denominated ABF fund in HK (ticker 2821) is attractive but IB doesn’t allow one to buy it.

Anyway I’m thing of adding some ZN, ZB and GBL to my portfolio, in the very near term, not sure yet wether to sell atm puts on ZN and ZB or buy the futures outright.
 
Also I've been preferring cash over bonds for a while because I was afraid of equities and bond moving in tandem with the market afraid of rising rates but it seems all long term portfolios include both equities and bonds, anyone's thoughts on the matter ?
 
"When fed hikes rates, the yield is supposed to go up as much as the financing cost, isn't it ?"
Perhaps, but if you are long the futures you will lose money as this happens. Furthermore, the Fed can flatten or invert the yield curve. during an inversion, the strategy could have a negative carry

As far as using options, I doubt there are any advantages as people already take libor in consideration while pricing options

ETFs are to be avoided for non-US UNLESS there are liquid options in them, in that case you can structure some options strategies that allow you to capture the dividend in the form of a capital gain and hence avoid the 30% withholding. If you want some yield over USTs, you can just buy corporate bonds outright, like 5 or 6 of them, from high quality companies. You get the full yield instead of the reduced yield of the ETF
 
luisHK said:
Also I've been preferring cash over bonds for a while because I was afraid of equities and bond moving in tandem with the market afraid of rising rates but it seems all long term portfolios include both equities and bonds, anyone's thoughts on the matter ?
More...
A bear market in stocks combined with one in bonds is a possibility but it looks unlikely as the Fed seems committed to come to the rescue of stocks. The latest FOMC minutes confirm this. Its a risk to keep in mind but not to the point where one would hold cash instead of bonds. If you are really afraid of hikes, you can keep durations low. Maybe even buy something like 1-2y corporate bonds (from high quality companies like JNJ, PG, BRKB), you get some yield and low interest rate risk.
 
Also, with ETFs you can avoid the 30% withholding using Single Stock Futures (in case the ETF has them). SSFs do have the libor financing drag I was referring to earlier but depending on the yield of the ETF, it might be worth it (specially because you will put 0 money down, so you can earn interest in the collateral and hence offset the drag)
But the problem is that most ETFs don't have SSFs and sometimes there is no liquidity. LQD is an example of an ETF with no market makers there. Why are they not making a market is beyond me
 
Daal

Thanks for your input, I might end up buying corporate bonds, but one issue is I'd like to buy them through a bank rather than an online broker and I don't like the rates i've encountered there so far

The possible plus in selling atm puts comes from IV beeing higher than realized vol, it's not related to Libor .
You can check the link below from the CME to the PUT index, there are several similar indexes studied on their site (I need to go through those again)
But considering ZN and ZB are non deliverable through IB, and probably other retail brokers, selling options on them onr expects to keep to expiration must make things complicated

http://www.cboe.com/micro/put/default.aspx

I've started checking ssf on bond ETFs, so far I haven't found any volume whatsover
 
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