TLT - Why Is Income from Govt Obligations so LOW?

Discussion of the Bond portion of the Permanent Portfolio

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

Post by clacy » Wed Feb 29, 2012 9:56 am

I think I will reduce my TLT to a smaller position, just enough for rebalance purposes and move most of it to actual treasuries.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by Gosso » Wed Feb 29, 2012 10:08 am

WildAboutHarry wrote:
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.
As far as I know they cannot lend shares in your IRA/401(k).  The reason they can lend shares in your margin account is because they are giving you the 'privilege' of borrowing cheap money from them to invest on margin.  Otherwise they wouldn't lend you the money at such a low rate.

When you're using a margin account you do not hold claim to any individual shares of the stock/etf you 'think' you own.  You own a certain percentage of the total pooled shares owned by the brokerage.  So a Margin Account is the same as unallocated gold, whereas a Cash Account is more like allocated gold.

It is stuff like this that make me appreciate the 25% in gold.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by WildAboutHarry » Wed Feb 29, 2012 10:26 am

Gosso wrote:So a Margin Account is the same as unallocated gold, whereas a Cash Account is more like allocated gold.
Thanks.  Assuming one has access to brokerage windows in tax-sheltered accounts that gives some coverage.

Although I think all shares, both cash and margin accounts alike, are typically held in street name and thus the cash-account shares are a bit closer to the un-allocated portion of the spectrum.

And I do like the concept of "deep assets".  MediumTex should trademark that before someone else does.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by Gosso » Wed Feb 29, 2012 10:42 am

WildAboutHarry wrote:
Gosso wrote:So a Margin Account is the same as unallocated gold, whereas a Cash Account is more like allocated gold.
Although I think all shares, both cash and margin accounts alike, are typically held in street name and thus the cash-account shares are a bit closer to the un-allocated portion of the spectrum.
You could be right about the shares in the cash-account being in a pool except unable to be lent out -- I only asked my broker about the margin account.  Plus the rules may be different between Canada and the US?
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by rickb » Wed Feb 29, 2012 10:54 am

MediumTex wrote: 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

Minor tweak - I would think the stocks should be in a fund, not ETF.  And I wouldn't necessarily go for cheapest but rather most transparent.  If they're cheap they may be cheap for reason (like, oh I don't know, maybe they loan out their securities :) ).
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by moda0306 » Wed Feb 29, 2012 10:57 am

What really makes a mutual fund safer than an ETF?  Couldn't they engage in security lending within a mutual fund?
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by MediumTex » Wed Feb 29, 2012 12:00 pm

rickb wrote:
MediumTex wrote: 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

Minor tweak - I would think the stocks should be in a fund, not ETF.  And I wouldn't necessarily go for cheapest but rather most transparent.  If they're cheap they may be cheap for reason (like, oh I don't know, maybe they loan out their securities :) ).
Personally, I think that VTSMX is hard to beat overall for the stock portion, but apparently Vanguard's index ETFs are basically the same as their index mutual funds.

To me, the stock portion of the PP presents fewer obvious "deep asset" applications.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by craigr » Wed Feb 29, 2012 2:16 pm

The reality is that an individual cannot obtain the equal diversification with low costs of a stock index by doing it themselves. The fund is way cheaper, and likely safer in terms of diversification, than building their own portfolio of stocks. The Vanguard funds, as Tex points out, are hybrids. The ETFs they offer are share classes of the fund. If you own the ETF you are linked to the mutual fund itself. Vanguard does this because having the ETF attached to the fund allows them to do better tax management than a fund alone can do. Of all the ETFs, I probably like Vanguard's the most because of this arrangement. But the iShares ETFs and StateStreet ETFs do have good reputations.

As for the other points, it is always best to own the bonds directly if you can. This is always the #1 option. Using a bond fund is a compromise and yes the prospectus allows managers to do things that may not be a benefit to all shareholders all the time. There is no way to control this manager risk other than to be your own manager. That's just the tradeoff for the convenience of a fund. But owning bonds is probably one of the easiest assets to hold. Once you make the purchase, they just sit there and pay you interest twice a year and not make any noise. You don't even need to feed them anything.

In terms of margin, yes this is a risk. I should probably write about this. Investors should not sign margin agreements and should have their accounts be cash only. It may not be perfect, but it eliminates one more risk. But as we all know, the Permanent Portfolio never uses margin investing (even in the Variable Portfolio), so no margin privilege is ever needed. It can only cause trouble.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by rickb » Wed Feb 29, 2012 2:56 pm

moda0306 wrote: What really makes a mutual fund safer than an ETF?   Couldn't they engage in security lending within a mutual fund?
ETFs are much more complicated beasts than mutual funds.  Either can (and many do) engage in security lending, so there's really not much difference on that score - but the indirect linkage between an ETF's market price and the NAV of the underlying assets (maintained by the actions of the authorized participants) is a complication that's simply not there with mutual funds.  

ETFs should theoretically be cheaper since the securities buying and selling is done by APs (who, in return, are able to profit from differences in the ETF's share price and its NAV).  And, indeed, VTI's ER is 0.06% while VTSMX's is 0.17% and VTSAX's (admiral class shares) is 0.07%.  However, the tradeoff is the additional complexity and the fact that the ETF's share price is not simply the NAV of the fund's assets.  For example, how did VTI do during the flash crash?  My recollection is it dropped to essentially $0.00 (maybe it was $0.01) even though the NAV was $50 or so.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by craigr » Wed Feb 29, 2012 3:33 pm

rickb wrote:ETFs should theoretically be cheaper since the securities buying and selling is done by APs (who, in return, are able to profit from differences in the ETF's share price and its NAV).  And, indeed, VTI's ER is 0.06% while VTSMX's is 0.17% and VTSAX's (admiral class shares) is 0.07%.  However, the tradeoff is the additional complexity and the fact that the ETF's share price is not simply the NAV of the fund's assets.  For example, how did VTI do during the flash crash?  My recollection is it dropped to essentially $0.00 (maybe it was $0.01) even though the NAV was $50 or so.
Great points.

Yes the benefit of the fund is you deposit your money and get end of day closing price. No need to worry about bid-ask spreads, commissions, etc. For someone in the Permanent Portfolio there is so little trading that the intra-day pricing of ETFs is not an advantage anyway.

The flash crash problem is there for sure. But this can be eliminated by not using stop limits which prevents getting whipsawed.

With that said, there is a risk of non-Vanguard funds having taxes from large scale redemptions. If a massive panic were to happen the selling of the funds could generate capital gains that get tossed into the laps of the remaining holders. With the Vanguard setup, they use the ETF outlet to manage this outflow by tossing the selling activity directly into the market through the ETFs and not onto the remaining fundholders.

FYI. Vanguard has a patent on this approach which is why nobody else does it in the fund industry.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by WildAboutHarry » Wed Feb 29, 2012 7:11 pm

CraigR wrote:Yes the benefit of the fund is you deposit your money and get end of day closing price. No need to worry about bid-ask spreads, commissions, etc. For someone in the Permanent Portfolio there is so little trading that the intra-day pricing of ETFs is not an advantage anyway.
I agree and much prefer funds to ETFs for all of the obvious reasons.

One problem with modern investing in general is there are too many damn choices. 

For example, Vanguard came out with free ETFs in their accounts, so off I went to ETFs.  A short time later -- listen to the paranoia creep in -- they offered many of the same funds as Admiral shares at $10K minimums.  So now I am stuck with ETFs when I really want to be in funds.  And it takes three days to unwind an ETF position to get back into funds at Vanguard.

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

Post by murphy_p_t » Wed Feb 29, 2012 10:16 pm

WildAboutHarry wrote:
CraigR wrote:Yes the benefit of the fund is you deposit your money and get end of day closing price. No need to worry about bid-ask spreads, commissions, etc. For someone in the Permanent Portfolio there is so little trading that the intra-day pricing of ETFs is not an advantage anyway.
I agree and much prefer funds to ETFs for all of the obvious reasons.

One problem with modern investing in general is there are too many damn choices. 

For example, Vanguard came out with free ETFs in their accounts, so off I went to ETFs.  A short time later -- listen to the paranoia creep in -- they offered many of the same funds as Admiral shares at $10K minimums.  So now I am stuck with ETFs when I really want to be in funds.  And it takes three days to unwind an ETF position to get back into funds at Vanguard.

Go figure.




learning things like this from folks who have no monetary interest is one thing makes this board so helpful...as always, thanks to all, esp CraigR
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by shoestring » Thu Mar 01, 2012 8:25 am

I have to echo that last sentiment.  I have followed this thread with great interest as a TLT holder.  Now I'm suddenly not feeling so smart for holding TLT.

Damn.  I love one stop shopping.  How hard is it to just buy a basket of long treasuries, sit on them, and skim fees off of people like me?  Seems like good pay for little work.

Direct holdings for some portion, and investigation of perhaps VGLT and/or EDV (volatility capture) for the rest, seem to be the recourse at the moment.

I hate when I lose faith in a consumer product.  I wonder if TLT/VGLT are different enough (I think they are but the IRS might not) you could at least do some tax loss harvesting.
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Re: TLT - Why Is Income from Govt Obligations so LOW?

Post by craigr » Thu Mar 01, 2012 11:32 am

WildAboutHarry wrote:
CraigR wrote:Yes the benefit of the fund is you deposit your money and get end of day closing price. No need to worry about bid-ask spreads, commissions, etc. For someone in the Permanent Portfolio there is so little trading that the intra-day pricing of ETFs is not an advantage anyway.
I agree and much prefer funds to ETFs for all of the obvious reasons.

One problem with modern investing in general is there are too many damn choices.  

For example, Vanguard came out with free ETFs in their accounts, so off I went to ETFs.  A short time later -- listen to the paranoia creep in -- they offered many of the same funds as Admiral shares at $10K minimums.  So now I am stuck with ETFs when I really want to be in funds.  And it takes three days to unwind an ETF position to get back into funds at Vanguard.

Go figure.
Of the ETFs, the Vanguard ones are least likely to have problems. IMO. They are just shares of the main fund. So I wouldn't worry about what you have. However I would not put in automatic stop limit orders on them just in case we get Flash Crash 2.0. If there is some kind of serious problem in the market you want to be able to evaluate the situation yourself and not have some automated tools doing things for you.

But with that said, the iShares are pretty decent as well and are getting a good track record. I am not thrilled with what is happening in TLT, but then you look at Vanguard's Treasury funds and they have a decent percent (now around 13%) in mortgages. The number had even been higher in the past. They may also enter into repo agreements that could generate non-treasury income as well at their discretion.

Really the only way to avoid the decisions of bond fund managers is to be your own bond fund manager and just buy the things directly. I wish it weren't the case, but sadly it just is.
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