PowerShares, Deutsche Bank Team Up On 3x Leveraged Bond ETNs

by on July 1, 2010 | ETFs Mentioned:

PowerShares and Deutsche Bank have expanded their ETF partnership, rolling out a pair of 3x leveraged ETNs offering amplified exposure to long-term Treasuries. The two products, which started trading on Wednesday, include:

  • PowerShares DB 3x Long 25+ Year Treasury Bond ETN (LBND)
  • PowerShares DB 3x Short 25+ Year Treasury Bond ETN (SBND)

As the names of these products suggest, LBND and SBND are designed to offer exposure to long-term Treasury Bonds. The indexes to which each are linked measure the performance of investments in Ultra T-Bond Futures, contracts traded on the CBOT whose underlying assets are U.S. Treasury Bonds with a remaining term to maturity of not less than 25 years from the first day of the futures contract delivery month [see all ETFs in the Leveraged Bonds ETFdb Category].

Shorting Treasuries

In recent years, short exposure to long-term Treasuries has become an increasingly popular option for investors. Perhaps the best evidence of this trend is the tremendous popularity of the ProShares UltraShort 20+ Year Treasury (TBT), which currently has more than $4 billion in assets. TBT seeks to deliver daily returns of -200% of the daily change in the Barclays Capital 20+ Year U.S. Treasury Index, a benchmark that consists of long-term government bonds. With interest rates at near-zero levels, investors have reasoned that there is nowhere to go but up. Because rising rates make coupons offered by existing bonds less attractive, rate hikes generally have an adverse impact on fixed income securities. The longer the duration of a bond, the more significant the impact of a tightening cycle, making short exposure to long-dated securities a popular way bet on interest rate hikes.

There is, of course, another side to that coin as well. With storm clouds forming over global equity markets, the appeal of safe havens has surged in recent months. With short-term bonds offering anemic yields, many investors have gravitated towards longer-term securities that can offer a meaningful coupon payment.

Similar, But Different

The exposure offered by LBND and SBND will be generally similar to TBT and its long counterpart, the ProShares Ultra 20+ Year Treasury (UBT). But the new PowerShares products will be different in several aspects as well; some of the distinctions are obvious, while others are more nuanced. First, LBND and SBND offer 3x leveraged exposure to long-term Treasuries, while TBT and UBT offer 200% leverage. Second, LBND and SBND are structured as exchange-traded notes (ETNs), meaning that they are senior unsubordinated debt instruments issued by a bank; the ProShares products are ETFs. ETNs generally exhibit lower tracking error, but do expose investors to the credit risk of the issuing institution (in this case, Deutsche Bank).

Additionally, the ProShares ETFs seek daily results corresponding to a multiple of the daily change in the underlying indexes. As noted in the prospectus, LBND and SBND are “linked to the month-over-month performance of an underlying index.” That’s a major distinction; given the complexities of compounding returns, the risk and return profiles offered by TBT and SBND will be very different. Because the PowerShares DB products compound only 12 times per year, they will be less susceptible to both an erosion of returns in choppy markets and an enhancement of returns in trending markets.

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Disclosure: No positions at time of writing