TLT - Why Is Income from Govt Obligations so LOW?

Discussion of the Bond portion of the Permanent Portfolio

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

Post by rickb » Fri Mar 09, 2012 10:55 am

murphy_p_t wrote: is the concern with TLT also applicable to SHY/SHV?
WildAboutHarry wrote: Yes
I agree the answer is yes, but if they actually hold 100% cash collateral, marked to market every day, the risk for loans involving the bonds held by SHY/SHV is considerably different because these bonds are so much less volatile than the long term treasuries held by TLT.   The main risk we've talked about regarding TLT is that the borrower (who has almost certainly sold the borrowed bonds short) gets caught on the wrong side of a large, sudden downward move in interest rates - and can't afford the cash to mark to the new market price (and then defaults, and all manner of ugliness ensues).  The shorter duration of the bonds held by SHY/SHV makes the potential mark to market obligation for these much, much less (at least in percentage terms), so a default based on a price spike would seem to be fairly unlikely (and they pay approximately 0% now anyway, so how much lower can interest rates really go?). On the other hand, one might wonder what form(s) of "cash" the fund considers acceptable as collateral and what the fund does with this cash for the duration of the loan - I mean, they probably don't insist on stacks of dollar bills and then put these dollars in a vault.  I'm sure if you called them up they'd be happy to tell you all the gory details - unless of course they're hiding something in which case they either won't tell you or they'll lie to you.

The question boils down to how much do you really trust iShares (BlackRock) to be appropriately managing any risks that might be involved in these sorts of loans, presumably up to and including making these funds "whole" again in the face of any problems that might occur.  Are they completely trustworthy, or might they become the next MF Global?  If you directly hold long term treasuries (even through a broker), directly hold short term treasuries, and hold physical gold only 25% of your assets are subject to these (presumably remote) sorts of risks.  Yes, there are other risks involved - but ask yourself, "what's the worst that can happen"?  Part of the genius of Browne's preferred allocation is that not only are the asset classes diversified in a return sense, but they're also so different that they're diversified in a fundamental risk sense. If you hold the assets in the preferred form, any one risk is effectively firewalled to only one asset class.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by WildAboutHarry » Fri Mar 09, 2012 11:21 am

Agree about relative risk, but if you are expecting income of a specific kind, and the "treasury" fund only delivers 50% from that source, that is misleading on the part of the fund at best.
It is the settled policy of America, that as peace is better than war, war is better than tribute.  The United States, while they wish for war with no nation, will buy peace with none"  James Madison
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by alvinroast » Fri Mar 09, 2012 12:18 pm

I agree about the relative risk since ST rates are so low. (Although if they go negative that would get very interesting).

I'm a bit biased since I have close to zero trust in Blackrock. When liquidating my wife's fund holdings I found that there was a whole lot of self dealing going on. The stock fund she was in was loaning upwards of 5% of it's funds to another Blackrock unit. The way I see it if I wanted to invest in Blackrock I would do so directly. There seem to be so many layers of counter-party risk just within Blackrock itself that I wouldn't want anything to do with them even if a specific fund seemed transparent.

Of course I'm not exactly thrilled about the 20% non-treasury in VG treasury funds either. ::)

Now that TreasuryDirect has finally approved us to loan money to the government (apparently they are concerned that terrorists will try to loan money to the government or something) we can just go direct for the "deep assets" TM? Has MT trademarked that yet?
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by rickb » Sat Mar 10, 2012 12:12 am

WildAboutHarry wrote: Agree about relative risk, but if you are expecting income of a specific kind, and the "treasury" fund only delivers 50% from that source, that is misleading on the part of the fund at best.
If this is "extra" income (income that would simply not be there if they didn't do the fancy lending) why do you care?  I don't know the accounting rules, but I'm assuming if they have, say, $1M of LT bonds paying 3% they report $30,000 of however much income the fund generates as "treasury" interest whether these bonds are loaned out or not - and if they're loaned out they might generate an additional (wild ass guess) 1% interest, so $10,000 more.  Given these numbers, they'd report 75% of their income from "treasury" sources - but the income would only be 75% of the reported total if they didn't do the lending.  I think the bottom line is the lending generates more income than the bonds would generate without the lending - supporting the claim that this is a "net benefit" for the shareholder.
alvinroast wrote: I'm a bit biased since I have close to zero trust in Blackrock.
I'm with you 100%.  I used to keep all of my LT bond allocation in TLT and a very large portion of my cash allocation in SHY.  Due to the various threads here about loaning assets and after some reflection about it, I've liquidated all the TLT in favor of actual LT bonds (this was remarkably easy - I would strongly encourage anyone here who can buy LT bonds directly to do so), and I'm setting up a ladder of 2-year bonds that I'm moving cash into (out of SHY).  I-bonds for cash are great as well, although the limits on how much you can purchase are kind of annoying.

Other people may completely trust BlackRock.  I'm OK with that as long as it's an "eyes wide open" situation.  However, someone with 25% LT bonds in TLT, 25% cash in SHY, and 25% gold in IAU has 75% of their assets with BlackRock.  I'd consider this crazy.  And I think Harry Browne would agree.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by WildAboutHarry » Sat Mar 10, 2012 9:20 am

...why do you care?
Because of state taxes in taxable accounts and taxable HSAs in CA and a few other states.
It is the settled policy of America, that as peace is better than war, war is better than tribute.  The United States, while they wish for war with no nation, will buy peace with none"  James Madison
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by fnord123 » Sat Mar 10, 2012 10:32 am

rickb wrote:Other people may completely trust BlackRock.  I'm OK with that as long as it's an "eyes wide open" situation.  However, someone with 25% LT bonds in TLT, 25% cash in SHY, and 25% gold in IAU has 75% of their assets with BlackRock.  I'd consider this crazy.  And I think Harry Browne would agree.
This is to me the strongest argument to reduce my TLT holdings.  One of the big benefits of indexing is diversification, so the PP uses an index for the stock portion of the portfolio.  The PP itself is extremely diversified, with 4 relatively uncorrelated asset classes.  Diversification is very valuable in terms of decreasing risk.  If BlackRock turns into another MFGlobal tomorrow, I would want to make sure my exposure to it as a firm would be small enough that my portfolio doesn't get trashed.

As a result of this thread I just sold a good size pile of TLT and put in a buy order @ Vanguard for yesterday's 30yr Feb 2042 treasury re-open.  With whatever is left I plan on buying 30yr treasuries on the secondary market.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by AgAuMoney » Sun Mar 11, 2012 3:41 pm

rickb wrote: Other people may completely trust BlackRock.  I'm OK with that as long as it's an "eyes wide open" situation.  However, someone with 25% LT bonds in TLT, 25% cash in SHY, and 25% gold in IAU has 75% of their assets with BlackRock.  I'd consider this crazy.  And I think Harry Browne would agree.
I agree you need to be aware that blackrock is the custodian for those funds.

However, it isn't like blackrock has any ownership claim on the assets in those funds.

in other words, blackrock is the custodian, and even if they were to go completely bankrupt they and their creditors have no claim on the assets in the funds.

A custodian is like putting cash into a safe deposit box in a bank as compared to depositing cash into a bank account.  When you make a deposit, you lend money to the bank and they promise to give you your money back later.  When you put cash into a safe deposit box the bank promises to keep your box safe for you, and you can get insurance on the the contents of that box should the bank fail to keep its promise (eg as a rider on your homeowners insurance).  The amount you have on deposit in a bank account is listed as an asset on the balance sheet of the bank, and if they go bankrupt all assets including your "balance" are divided amongst the creditors.  (FDIC insurance is a depression-era attempt to ameliorate fear of that risk.)  The safe deposit box contents are exclusively yours.

Any malfeasance on the part of blackrock where they misappropriate the assets in the funds is what your broker's SIPC insurance (and supplemental insurance for amounts in excess of SIPC) is supposed to cover.

This is nothing like an MF Global situation because hedge funds are an entirely different structure than mutual funds and ETFs.  Putting money in a hedge fund is more like depositing money into a bank account than like putting cash into a safe deposit box or money into an ETF.  It is a bit more complicated because of securities regulations, and that's part of the reason for the increased discussion about what it means and takes to be a qualified investor for purposes of investing in a hedge fund.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by fnord123 » Sun Mar 11, 2012 7:06 pm

AgAuMoney wrote:This is nothing like an MF Global situation because hedge funds are an entirely different structure than mutual funds and ETFs.
MF Global was not a hedge fund, it was a derivative broker and a primary dealer.  Perhaps you are thinking of Man Group, which was indeed similar to a hedge fund.  MF Global has been a distinct legal entity from Man Group since 2007.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by AgAuMoney » Sat Mar 17, 2012 1:38 pm

fnord123 wrote:MF Global has been a distinct legal entity from Man Group since 2007.
Thanks for the correction.

MF Global was indeed operating as a broker-dealer, and the problem was they mingled customer assets with their own and lost one or more big bets.  Accounts with them were similar to a custodial arrangement ala Blackrock, but more comparable to your typical brokerage account.  (I'm not positive, but it appears all the accounts with MF Global would have been "margin" accounts.)

Where it gets really messy, is that MF Global claims the customer assets were collateral (for their margin), therefore rehypothecation was allowed as customary use even if not desirable or even suspected by the account holders.  Those customers still have legal title, but because of their account agreements may have assumed this additional risk (and should have known about it).  It has to be settled by Mr. Freeh in bankruptcy court.  :(

(Hypothecation being the pledge or surrender of assets as collateral for a debt, e.g. pawning a ring, taking out a mortgage, a car title loan, or a margin account.  Rehypothecation is when whomever you surrendered your assets for collateral uses them as collateral for their own loan, e.g. a pawnshop repawning your stuff with someone else while you still have a claim to the goods.)

In a brokerage cash account, as opposed to a margin account, your assets are not pledged as collateral.

I don't recall anything from the Blackrock legalese that would mean hypothecation.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by jco » Wed Mar 21, 2012 8:25 am

Very disturbing... Maybe we could start a petition of some kind and try to get them to address these concerns?

I'd sell it outright but I have a lot of capital gains in TLT waiting... And my taxable income will be much lower next year. :-\

... Damnit, was so happy with TLT; easy to liquidate, monthly dividends >:( Wall St is just incapable of not screwing with a good thing.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by murphy_p_t » Sun Mar 25, 2012 6:21 pm

jco wrote: Very disturbing... Maybe we could start a petition of some kind and try to get them to address these concerns?
when it comes to markets / capitalist system, i think the way operators take notice is thru buy/selling...
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by moda0306 » Wed Mar 28, 2012 11:14 am

murphy_p_t wrote:
jco wrote: Very disturbing... Maybe we could start a petition of some kind and try to get them to address these concerns?
when it comes to markets / capitalist system, i think the way operators take notice is thru buy/selling...
Of course, once you throw human nature into the equation, only once the SHTF does the market react.  We are sheep... well not us in this forum, but the investing public in general.
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