TLT - Why Is Income from Govt Obligations so LOW?

Discussion of the Bond portion of the Permanent Portfolio

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

Post by WildAboutHarry » Sun Apr 01, 2012 8:16 am

Xan wrote:Well, many folks (like myself) live in states with no income tax.
While that takes care of the state tax problem with TLT in taxable for those so blessed, if half of the income from TLT is derived from non-treasury sources, but they are priced to yield like treasury bonds, where does all that extra money go?

In other words, is I-Shares making money on securities lending and other securities jiggery pokery on the treasury holdings to collect fees in excess of the treasury yields and then paying out enough to shareholders just to match applicable treasury yields?  And pocketing the difference?
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by rickb » Mon Apr 02, 2012 2:09 pm

WildAboutHarry wrote: ... if half of the income from TLT is derived from non-treasury sources, but they are priced to yield like treasury bonds, where does all that extra money go?

In other words, is I-Shares making money on securities lending and other securities jiggery pokery on the treasury holdings to collect fees in excess of the treasury yields and then paying out enough to shareholders just to match applicable treasury yields?  And pocketing the difference?
Nothing more than a complete guess - but I'd imagine they can't pocket the difference without reporting it as fees.  On the other hand (still guessing) I wouldn't be in the least surprised if the treasury loans are indirected through a subsidiary that charges fairly exorbitant fees letting the fund report a profit from its lending operation (effectively reducing the fund's reported fees) - while allowing the subsidiary to siphon off as much of the "excess" interest as they want.  On paper this would be a win-win - the fund reports better interest and lower fees than it otherwise would (enabling the fund to match any low-cost provider's [cough**Vanguard**cough] fees), and the subsidiary makes a tidy profit.

Rather than continue to guess about all this, it would be good if someone who knows about this kind of stuff could look into it and let us know what they find.  It all has to be above board and reported someplace, right?
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by moda0306 » Mon Apr 02, 2012 2:14 pm

rickb,

I, like you, can't wait for somebody to bust open this gravy train.  I just know if I call i-shares it'll take forever to get the bottom of this, if it's even possible.

Someone here has to have some financial connections.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by WildAboutHarry » Tue Apr 03, 2012 7:23 am

rickb - I think your hypothetical sounds like a very reasonable scenario.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by Pointedstick » Tue May 29, 2012 5:45 pm

Was there ever any resolution on this? I just happened to buy a bunch of TLT and I'm getting a tad nervous.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by Tyler » Tue May 29, 2012 7:50 pm

I personally see no reason to lose sleep over TLT at this point.  Yes, they have non-treasury income that could result in an unexpected state tax bill.  Yet while it surely has more risk than treasuries through Treasury Direct I have seen nothing to make me believe it is high risk overall.  

Going back to some of Craig's recent posts, I'm personally more worried about putting all my money in the iShares basket than about TLT individually.  Spread your money among different companies and you'll build healthy firewalls for counter-party risk even for the funds you're 100% convinced are safe right now but may have issues tomorrow.

Even direct treasuries through Fidelity may not be the safest plan if you're also counting on FDLXX and FSTMX, for example.  
Last edited by Tyler on Tue May 29, 2012 7:52 pm, edited 1 time in total.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by rickb » Sat Jun 02, 2012 7:02 pm

In their 2012 Annual Report (see Note 5)  iShares says

1. They lend to approved borrowers (brokers, dealers and other financial institutions).  They don't say exactly who.

2. The borrower puts up collateral consisting of cash, an irrevocable letter of credit, or securities issued or guaranteed by the U.S. government in an initial amount of 102% of the current value of what they borrow, maintained at a value of at least 100% of the current value of what's borrowed.  

3. They may reinvest the collateral in "certain short-term instruments ... in one or more joint accounts or money market funds, including those managed by BFA [Black Rock] or its affiliates.  Each Fund could suffer a loss if the value of an investment purchased with cash collateral falls below the value of the cash collateral received."

4. As of Feb 29, 2012 any securities on loan were collateralized by cash, and the cash was invested in money market funds managed by BFA.  They don't say exactly which money market funds.

5. Securities lending income (reported elsewhere in the report as $1.5M) is the income earned from the investment of the cash collateral, net of fees and other payments to and from borrowers, and less the fees paid to BTC [Black Rock] as the lending agent.

Elsewhere, they say about $1B of the $4B of TLT's net assets are currently loaned.

Also elsewhere (Note 2), they say the lending agent fees are 35% of the income derived from lending, and were $823K.

The bottom line seems to be that 25% of TLT's assets are actually invested in money market funds, but they collect all of the bond interest plus 65% of the interest the money market fund is paying.

[edit: $1B of $4B, not $1T of $4T]
Last edited by rickb on Sun Jun 03, 2012 12:11 pm, edited 1 time in total.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by Tyler » Sat Jun 02, 2012 7:27 pm

Thanks for the info.

So the biggest risk seems to be the credit risk of the money market funds in a major economic nosedive.  That's certainly a risk (there's a reason HB advocated treasury MM funds), but less so than other investments they could have screwed around with.  Any idea what kind of insurance may be in place for that portion of the money if there wan an issue with the MM fund?  

EDIT: Digging through the annual report, the primary money market fund used is "Blackrock Cash Funds: Institutional, SL Agency Shares".  Just in case that means anything to anyone here.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by rickb » Sat Jun 02, 2012 8:44 pm

Tyler wrote: Any idea what kind of insurance may be in place for that portion of the money if there wan an issue with the MM fund? 
Guessing, I suspect the answer is none.  On the other hand, many fund families are extremely reluctant to let their MM funds "break the buck" so in all likelihood this would be an event where Black Rock was in serious trouble - but avoiding this same risk is kind of the point of using treasury backed MM funds for the PP's cash portion.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by Tyler » Sun Jun 03, 2012 12:39 am

Makes sense.  So if their securities lending income is solely from interest on the 100% cash collateral marked to market every day and invested in an established institutional MMF under the same company umbrella (that they have a vested interest in preserving), then that sounds to me like a higher risk setup than direct treasuries but still a reasonably low risk as far as Wall Street machinations go.  Enough to make you think about it (and look at direct treasuries as an alternative), but not enough to lose sleep over if you own some TLT.  The odds of losing large chunks of capital seem pretty low.  More likely, you may simply see returns that trail direct treasuries should a borrower not be able to pay up on a days worth of volatility or the fund need to cover losses in the MMF collateral if they over-extended themselves for yield and lost money with risky investments.  

Incidentally, a quick search indicates that many Fidelity/Schwab/other funds appear to operate under a similar setup so this doesn't seem to be just a Blackrock thing.  Doesn't make it right, though.

Anyone can correct me if I'm missing something.
Last edited by Tyler on Sun Jun 03, 2012 2:17 am, edited 1 time in total.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by rickb » Sun Jun 03, 2012 2:16 am

Tyler wrote: Enough to make you think about it (and look at direct treasuries as an alternative), but not enough to lose sleep over if you own some TLT.  The odds of losing large chunks of capital seem pretty low.  More likely, you may simply see returns that trail direct treasuries should a borrower not be able to pay up on a days worth of volatility or the fund need to cover losses in the MMF collateral if they over-extended themselves for yield and lost money with risky investments. 
I'd say this a little stronger.  If you possibly can, buy long term treasuries directly.  If you can't, TLT may be a reasonable alternative but be aware that it has risks that directly holding long term treasuries does not.  In many ways, it's similar to buying actual gold coins as opposed to any of the gold ETFs or closed end funds. 
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by Tyler » Sun Jun 03, 2012 2:18 am

Understood.

One thing I was wondering, though -- from Gumby's Treasury Bond Buying Tutorial, there's a note at the bottom that even direct bonds held at a broker are held in their street name and can be lent out at their discretion (that's why they're willing to offer free bond trades).  Just curious -- how is this different/better/safer than when iShares does it?
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by hoost » Sun Jun 03, 2012 2:20 am

Tyler wrote: Understood.

One thing I was wondering, though -- from Gumby's Treasury Bond Buying Tutorial, there's a note at the bottom that even direct bonds held at a broker are held in their street name and can be lent out at their discretion (that's why they're willing to offer free bond trades).  Just curious -- how is this different/better/safer than when iShares does it?
That's a good question.  Offhand, it seems like there are less pieces of paper between you and the bond and less expenses; however, I may be completely missing a major risk, so take that with a grain of salt.  I'd be interested to hear opinions to the contrary.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by rickb » Sun Jun 03, 2012 12:24 pm

Tyler wrote: Understood.

One thing I was wondering, though -- from Gumby's Treasury Bond Buying Tutorial, there's a note at the bottom that even direct bonds held at a broker are held in their street name and can be lent out at their discretion (that's why they're willing to offer free bond trades).  Just curious -- how is this different/better/safer than when iShares does it?
I believe that unless your account is specifically set up as a margin account the brokerage should not be lending out any securities in your account, and that the notion that anything held in street name in a non-margin account can be lent out is simply incorrect.  If anyone knows this for sure, please comment.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by Pointedstick » Sun Jun 03, 2012 7:19 pm

I swapped my TLT out for EDV (right before it happened to shoot up 9% too ;D ). I have a lot more trust in Vanguard, and this also gives me a bit more institutional diversification. I was 75% in iShares/BlackRock funds before!  :o
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by Tyler » Mon Jun 04, 2012 12:40 pm

I followed up with Fidelity and asked about lending of bonds purchased directly through your brokerage account.  Here is their response:

"With regard to how the bonds are held, they are held in street name just like any other securities held in your account with Fidelity; however, we do not lend out or hypothecate fully paid for securities in a cash account. This would only be done under certain circumstances in a margin account where you have agreed to this activity as part of the margin agreement."

So yes, holding bonds in a cash account (through Fidelity, at least) carries less risk than pretty much any fund.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by vnatale » Mon Jan 13, 2020 8:29 pm

From 8 years ago....

Concern was expressed that TLT does not derive all its income from government obligations since it loans out some of its assets. This then exposes some of the income from it to be taxed at that state income tax level.

I assume that nothing has changed with this?

Near the end Tyler expressed the opinion that while there was some risk in this it was fairly minimal.

I assume that nothing has changed with what TLT is doing?

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

Post by Kbg » Tue Jan 14, 2020 9:06 am

IDK one way or another, what I do know is there are actual equivalent alternatives to TLT now that have much cheaper fees from Vanguard and Schwab.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by Tyler » Tue Jan 14, 2020 10:56 am

One thing I've learned is that virtually all index funds today engage in securities lending. It's not just a TLT or BlackRock thing. State Street, Vanguard, Schwab -- they all do it. So if it bothers you, then you should really prioritize holding the assets directly rather than going through a fund.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by Kbg » Tue Jan 14, 2020 11:13 am

+1

Also, the owner remains the owner and they can pull back the lend at anytime usually. While it’s called stock lending the reality is more like renting your stocks out with appropriate ledger entries.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by Smith1776 » Tue Jan 14, 2020 2:04 pm

Yeah, Blackrock wrote a paper on this subject.

They claim that they've never lost customer assets from securities lending ever. And even the few times borrowers defaulted, they were fully protected from the collateral the borrowers posted. They simply took the collateral and bought the shares that had been lent out. Easy peasy on their end.

Still, I'm somewhat hesitant about securities lending that can go too far. If the market ever has liquidity issues there could be problems for the funds.

If I recall correctly, Vanguard's securities lending is much more modest than Blackrock.
I still find the James Rickards portfolio fascinating.
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