In 2011, Invesco PowerShares launched a one-of-a-kind ETN in the DB US Deflation ETN (DEFL ). While there are many funds dedicated to inflation and mitigating its impact, DEFL is the only to be wholly dedicated to deflation.
Inside DEFL's Strategy
Investors are very aware and comfortable with inflation-focused investments, but tracking deflation is not as simple as investing in a certain security. To track deflation, DEFL takes a short position in TIPS while simultaneously taking a long position in U.S. Treasuries of an approximately equal maturity.
In an inflationary environment, or if the market expects inflation to increase, TIPS tend to outperform Treasuries with the same maturity. For a deflationary environment, or if the market expects deflation, TIPS tend to underperform Treasuries with the same maturity. Because DEFL is focused on deflation, its short position in TIPS combined with a long position in Treasuries stands to benefit from deflation or the expectation of it.
As an interesting aside, if DEFL ever trades above $100 for three consecutive sessions, the fund will undergo a 2-for-1 split. Likewise, it the ETN ever trades below $25 for three consecutive sessions, the fund will undergo a 1-for-2 reverse split.
Considerations on DEFL's Performance
DEFL’s performance is hard to gauge, as the fund has not been presented with a consistent deflationary environment in its lifespan. In fact, it has been quite some time since the U.S. exhibited deflation with any kind of persistence. Even still, DEFL’s performance has been decent considering the scenario.
One thing that investors will want to keep an eye on is the fund’s trading volume. DEFL is thinly traded and is prone to going multiple sessions without trading at all. That can make its performance look out of whack when it resumes trading. Just remember that even if the fund is not trading, its underlying value is still moving as it is tied to the movements of TIPS and Treasuries; the change in its underlying value will be reflected on the day that it does trade again and can often confuse investors [see also Ten Commandments Of ETF Investing].
Though there has not been a significant period of deflation in quite some time, there have been minor stretches where prices have decreased. Should the U.S. see another deflationary stretch (minor or major), look for DEFL to not only step up its performance but also its popularity among investors.
How to Use DEFL in a Portfolio
DEFL would never be considered a core holding in a portfolio. Instead, it should be used as a satellite holding to help protect your investments against any kind of deflationary pressure. As mentioned above, DEFL’s strategy is somewhat complex in that it utilizes long and short positions; be sure that you fully understand how it operates prior to making any kind of investement.
The fund charges 75 basis points for investment, which may seem high for the exchange traded world, but when you consider the cost of employing its strategy on your own, 0.75% per year falls in at a reasonable level for investors.
The Bottom Line
DEFL offers a unique exposure that is found nowhere else in the ETF world. As always, be sure to take a close look under the hood of the fund prior to taking a position.
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Disclosure: No positions at time of writing.