TLT - Why Is Income from Govt Obligations so LOW?

Discussion of the Bond portion of the Permanent Portfolio

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dualstow
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by dualstow » Tue Feb 28, 2012 2:04 pm

stone wrote:dualstow, it probably still is fairly safe compared to pretty much everything else.
Yeah, but now I have to decide whether or not to talk to him about it. If I don't bring it up, TLT is sure to blow up someday. I'll just tell him and wait for him to say he doesn't care. I'm sure there are a few investors here who have 100% in TLT.
moda0306 wrote: dualstow,

Yeah if it sounded like I was lecturing you or trying to make a point against anything you said I wasn't... just typing in frustrated confusion.
Oh, you didn't sound like you were lecturing. When I said "I have no argument" I could as easily have written, "I agree!"
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by rickb » Tue Feb 28, 2012 2:37 pm

Thanks for contacting us about iShares ETFs. The reason you are seeing these numbers is because of securities lending activities within the fund. However we will not lend securities unless it was net benefit to the shareholder.
Hilarious.  The primary (only?) reason securities are borrowed from the ETF is to short them, which tends to suppress the price which sounds to me like a net detriment to the shareholder.

I suspect the "net benefit" iShares is talking about here has to do with the income from the lending operations.  It would be interesting to know if the reported ER is inclusive or exclusive of expenses incurred by the lending operations.  I wouldn't be in the least surprised if it's exclusive, meaning if they make $X through lending but only net $Y (< $X) after "expenses" they don't have to include the difference ($X-$Y) in their reported ER.  Even if this is how it works, as long as $Y is greater than 0, there's a "net benefit" to the shareholder.  However, if this is how it works there's potentially a far greater benefit to Blackrock than to the shareholder.

And, BTW, Vanguard does this too (lends securities) but since Vanguard is owned by its shareholders they don't do this so that they can put more money in their pockets.  As I understand it, all income Vanguard receives from its lending operations goes to reducing their fees (and they're extremely conservative about how much and to whom they're willing to lend).
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by moda0306 » Tue Feb 28, 2012 2:40 pm

I'm not as concerned about the shorters actually being able to move the market (actually, I didn't even think of that... that's even more reason not to like it), but I'm more concerned about borrowing wealth to a guy that's making leveraged bets against the security I'm lending him.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by Tortoise » Tue Feb 28, 2012 10:18 pm

This has been educational, guys. I'm glad I moved out of TLT and into directly held LT bonds a while back.

Sounds like TLT's lending activities will be completely harmless... until they aren't :-\

If someone were to take a poll, I wonder what fraction of TLT shareholders in the general population would say they're aware of the fact that the fund lends out a large fraction of its U.S. Treasury bonds (near-zero credit risk) to private speculators (certainly non-zero credit risk). It might be an exaggeration for me to say that this is fraud dressed in a cheap tuxedo, but I don't think so.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by rickb » Wed Feb 29, 2012 2:01 am

Tortoise wrote: If someone were to take a poll, I wonder what fraction of TLT shareholders in the general population would say they're aware of the fact that the fund lends out a large fraction of its U.S. Treasury bonds (near-zero credit risk) to private speculators (certainly non-zero credit risk). It might be an exaggeration for me to say that this is fraud dressed in a cheap tuxedo, but I don't think so.
I don't think the lending they do is in any way defensible, however I think it's perhaps not quite as bad as it may seem.  My understanding is the collateral for such loans is typically cash equal to 100% of the value of the loan, marked to market every day.  The exposure to the borrower's credit risk amounts to how much the price of the bonds might move in a single day.

This whole scheme leads to an interesting question -  what does the ETF do with the borrower's cash?  If they're loaning their shareholders' securities to make an extra buck or two, I find it hard to believe they'd let a fairly substantial pile of cash JUST SIT THERE!  OMFG - it's just sitting there not making any money at all!!??  I think the real danger here is not the borrower's creditworthiness, but what they might do with the borrower's cash.  I haven't read the prospectus in a while.  Maybe they spell all this out.  And maybe in their annual statements they say exactly who the borrowers are and what the ETF actually does with the cash kept as collateral.  I mean, it's not like they're greedy bastards who would sell out their own mother for a nickel - they're on the shareholder's side and they wouldn't be doing any of this if it didn't benefit the shareholder.  They said so themselves, right?  What could possibly go wrong?

Full disclosure: I used to hold my entire LT allocation in TLT but converted it to actual LT bonds 4 or 5 months ago in response to the initial thread here about funds/ETFs loaning securities.  I'm converting my SHY holdings to a short term ladder of actual bonds as well.  I think I'll sleep better when I'm done.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by stone » Wed Feb 29, 2012 3:54 am

I guess two sorts of people short treasuries. Some are simply trying to iron out discrepancies between the price of say a 2040 4% and a 2039 3.7% bond or whatever. They will be short 2040 4% and long 2039 3.7% for an hour or so until the small price discrepancy corrects. That all sounds very innocuous and generally is (but was what LTCM was based on :) ). The other people consider that LTT as an asset class are over valued on the basis of their macro wisdom. If the former type of people are not using much leverage (so not the 1000:1 as LTCM was :) ) then perhaps all is well. BUT who knows what else they are doing. There is a whole can of unknown unknowns. Why get connected to any of this when it is so easy to avoid it?
If you did want to get involved in that kind of thing it would seem to me to be healthier to trade options on LTT. At least then you would sort of be able to see what was happening ???
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by TripleB » Wed Feb 29, 2012 5:46 am

Just buy treasury bonds direct from auction or secondary market. Problem solved. It's not like the gold issue where if you have money in a retirement account, you can't hold gold coins directly for it.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by chrikenn » Wed Feb 29, 2012 8:37 am

Thanks for all the feedback on this.  I may gradually transition my TLT holdings to a combination of Vanguard's LT bond offering and EDV.  As I said in one of my original posts in this thread, Vanguard's LT bond offering results in 94%+ of the income from U.S. Govt. Obligations.  So perhaps Vanguard is doing a little bit of lending, but nowhere near to the extent that TLT is.  And I admit that the TLT stuff scares me a little bit.  If the primary reason we hold treasuries is to have the safest asset class possible, the lending clearly does not further that goal.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by Gosso » Wed Feb 29, 2012 8:48 am

I'd hate to throw gasoline on the fire but if you're using a margin account then your discount broker can lend out any shares that you own inside that account.  Some people claim that if you're not using the margin then they cannot lend the shares, but I was told differently when I asked my broker.  The solution is to switch to a "Cash account", which is what we all should be using anyway.

Honestly, I'm more worried about the broker than I am about iShares.
Last edited by Gosso on Wed Feb 29, 2012 8:51 am, edited 1 time in total.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by WildAboutHarry » Wed Feb 29, 2012 9:30 am

Gosso wrote:I'd hate to throw gasoline on the fire but if you're using a margin account then your discount broker can lend out any shares that you own inside that account. 
What about brokerage accounts for IRAs/401(k)s?  No margin there.  Can they lend securities from these accounts?

I'm concerned about the whole ETF/fund thing - broker, I-Shares, et al.  It is a chain forged of potentially very weak links.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by MediumTex » Wed Feb 29, 2012 9:36 am

I've talked about "deep assets" in each PP asset class, and this discussion just reinforces the need for the deep assets in the bond allocation to be actual treasury bonds.

An overall PP's deep assets might look like this:

Stocks: Cheapest S&P 500 fund you can find

Gold: Bullion

Cash: EE and I series savings bonds and t-bills

Bonds: 30 Year treasury bonds
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by moda0306 » Wed Feb 29, 2012 9:51 am

It's great that you get collateral and all, but you still are in effect loaning your wealth to a private entity that's actually making bets against your investment, hoping to reap the safety of a bond from the most stable entity in the world, the U.S. government.

Collateral of 102% of the security value is fine, until the security jumps 30% in value over a 3-4 month period, and we only have $102 where $130 should be, and the people that owe us $28 made bets the wrong way and can't pay us.

I can't remember how we stumbled on all this security-lending stuff, but it sure has been an education.
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