Is TLT (20 yr bond index) self hedging?

Discussion in 'ETFs' started by HFStartup, Jun 10, 2011.

  1. Given that the price of the bond and the interest rate share an inverse relationship, I have started to wonder if the iShares Barclays 20+ Year Treasury Bond ETF (ticker symbol TLT) is a self hedging is my reasoning, please let me know what I am missing.

    According to, "The iShares Barclays 10-20 Year Treasury Bond Fund seeks results that correspond generally to the price and yield performance, before fees and expense, of the long-term sector of the United States Treasury market as defined by the Barclays Capital U.S. 10-20 Year Treasury Bond Index."

    In addition, it has an Annual Holdings Turnover of 48% (according to YahooFinance!) and its current annual yield is 4.3%.

    Because nearly half of the ETF's inventory is turned over each year, theoretically it seems that as the price of TLT's share price falls, the yield will rise to compensate due to the acquisition of new bonds at the higher interest rates resulting in a self-hedging investment. Assuming there will be a "lag" between the yield of the ETF compared to the current market interest rates, is this correct?

    Thank you in advance for your input.
  2. This should sharpen things up -

    Short answer NO - TLT is highly exposed to changes in rates because of the bonds long duration... theres no process that would adjust to rates changing as you suggest...
  3. In a sense, a bond held to maturity is indeed a self-hedging instrument. I never thought of it that way though. If a bond is held to maturity, there is no loss of capital, assuming no call or default, and there is a return to compensate for interest rate changes but assuming that coupons are reinvested at the yield rate. So yes, I would agree with you as far as hedging in the case of bonds in general.

    TLT is a bond index fund essentially that tries to track the price and yield of a certain maturity. The major difference between TLT and bonds is that the former has no maturity so actually I would say that in the absence of commissions it would be a hedge to infinity. Since you pay management fee, holding it to infinity will result in an infinite cost (do not forget the properties of infinity).

    Thus, the short answer to your question is that TLT is not a hedge because it has no specified maturity.
  4. Thanks, Psytrade for the reference document. It is an excellent source of information and I appreciate the link.

    The point that you bring up is exactly the point that I find so confusing! You had mentioned that "TLT is highly exposed to changes in rates because of the bonds long duration."

    Logically I would assume that the fund would want to keep their capital working and therefore will be (near) fully invested in 20 year bonds to be an accurate reflection of the underlying. So what you are saying in that regard makes sense. And since they are 20 years in duration, I would think that once into a position, the capital would be tied up for 20 years. However, the annual turnover rate of nearly 50% suggests that approximately half of the positions are closed out each year and reinvested. If this is the case, wouldn't the new positions entered into with the newly available capital reflect the higher interest rate?

    Thanks again!
  5. Thanks Intradaybill! I apologize because despite the great posts on this thread, I am still apparently missing something. I just responded to another post which explains my confusion in greater detail.

    However, I recently read about interest rate immunization and I was wondering if that plays any role in the self hedging I originally proposed and if so, how would it be utilized and how would it affect performance?

    Thank you!
  6. I'm not quite sure I understand the question - does it help if you compare TLT with bond ladders? In my view it's not really a hedge, just a reflection of changing conditions.:)

    Immunization is a separate matter.
  7. Let me rephrase the question...

    How can the TLT ETF have a 48% annual turnover on an investment that requires such a long term commitment (20 years)?

  8. Maybe they buy bonds that have one year left to maturity, or maybe they just roll over 48% every year.

    Try looking at a chart of TLT price/20 year yield and see if there is much correlation. TLT did run up to 120 or so for a short time around 2008/2009 and then fell back down.
  9. That's a different question. They must make money, right? This is all about money. First they devised a bond index with 14 holdings. Then they devised an ETF that must track the index. Then, they rebalance the index and as a result the ETF must be rebalanced. This makes money for the Index managers. It is called Active Management.

    This is business. They give you a product and if you like it you invest in it. If it performs well, you should not care how they actively manage it. If you do not like it, you just don't invest with it. For example, USO is poorly tracking crude oil and I do not trade it any longer.
  10. The TLT is well managed....

    USO is just a scam for Market Makers to front run... Bloomberg pointed that out months ago..
    #10     Jun 12, 2011