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The first single-bond exchange traded funds in the world are set to list on the Nasdaq exchange on Tuesday, in a move that could revolutionise how some traders access US Treasuries.
The launches follow hot on the heels of the first single-stock ETFs in the US and illustrate a growing trend for vehicles to target ever more specific exposures, eschewing the diversification at the heart of the traditional fund structure.
The three ETFs will hold US 10-year, two-year or three-month US Treasury bonds and bills. They will always hold the latest issue of their respective tenor, known as the “on-the-run” bond, trading out of the previous issue as soon as a new security is released.
Issuer F/m Investments, a $4bn Washington DC-based multi-boutique, cited ease of access, tax efficiency and access to shorting and, eventually, options, as advantages of holding the ETFs rather than the underlying Treasuries.
“We believe the [ETFs} will revolutionise the financial markets, making the most liquid securities accessible to everyone in a more simplified way,” said Alexander Morris, president and chief investment officer of F/m.
“This [concept] has a certain level of deep simplicity. Why was it missed? . . . We couldn’t find any good answers to this, so we pushed the button.”
Morris said F/m was “responding to the needs of our clients”; investment advisers and institutional investors that do not want to deal with custody and treasury issues.
However, he believed the ETFs would also find an audience in the retail market, given that most retail investment platforms such as Robinhood do not allow people to buy individual bonds.
On-the-run and off-the-run Treasuries and how they affect the ETFs
Even for those that can buy underlying Treasuries, the process is not as simple as it sounds according to Alexander Morris, president and chief investment officer of F/m.
A newly issued 10-year Treasury will only provide precise access to the 10-year yield for 90 days, until it goes “off-the-run” and is supplanted by freshly issued paper. For two-year Treasuries this happens every month, and for three-month bills as recently as once a week.
As well as occupying a different spot on the yield curve, off-the-run bonds can rapidly lose liquidity. Rolling regularly to remain in the latest issue can come with significant spreads, commissions and transaction costs, and potentially capital gains tax liabilities, while the minimum denomination, $100, is twice that for F/m’s ETFs.
Given that there tends to be a price drop-off when a bond goes off-the-run, the ETFs are also likely to lose money when they roll into a new on-the-run bond.
But Morris argued this price dislocation was “not tremendously great”, and in a falling interest rate environment, which some foresee as happening as soon as next year, the roll is more likely to be profitable.
The ETFs, with the tickers UTEN, UTWO and TBIL, come with annual fees of 15 basis points.
Further launches are likely, with F/m having filed to launch a family of 10 single bond ETFs, ranging in tenor from three months to 30 years.
F/m currently manages one ETF in its own name (F/m Investments Large Cap Focused Fund) and three under the name of Oakhurst, one if its affiliates. The new ETFs are a collaboration between two more of its affiliates; North Slope Capital and Genoa Asset Management.
Kenneth Lamont, senior fund analyst for passive strategies at Morningstar, said the launches “should be applauded as another next step in the democratisation of finance”.
“For many years fixed income investing was the preserve of institutional investors. The arrival of the ETF wrapper helped facilitate smaller ticket investors’ entry into international bond markets. These launches go one step further and allow investors to gain targeted exposure to different parts of the yield curve,” Lamont said.
“These highly targeted building blocks allow investors to take a more nuanced view on rates. There is a definitely a clear use case here, which can’t be said for all new products coming to market right now.”
Nate Geraci, president of The ETF Store, was also upbeat about the prospects for F/m’s offerings.
“The fixed income arena continues to offer fertile ground for ETF innovation and issuers are slicing and dicing this market into more precise exposures,” he said, citing the example of BondBloxx, which launched a family of sector-specific high-yield bond ETFs earlier this year.
“With rising rates a primary concern for many investors, the ability to control duration risk has taken on greater importance,” Geraci added.
“Given the market environment, I expect these ETFs to find some success and wouldn’t be surprised to see additional launches in this space.”
Todd Rosenbluth, head of research at VettaFi, said although investors had “flocked to Treasury ETFs this year”, he feared that well established asset managers such as BlackRock had a “significant advantage” over a new entrant such as F/m, given the huge size of their current Treasury ETF offerings and the importance of liquidity.
“Unlike the single-stock inverse ETF from AXS that has experienced strong volume, these products will face entrenched ETF competition,” he added.
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