Why hasn't some enterprising outfit listed Treasury bonds on an exchange? Seems to me it should be just as easy or even easier than creating a Spider (SPY) - Get Report or a Nasdaq 100 Tracking Stock (QQQ) - Get Report. --Peter Cleaver
You may (emphasis on
) see such products before long. Experts say there's no reason such a product can't exist. But viable alternatives already exist, and it's not clear whether demand is sufficient for what you're describing.
This is an interesting question in an era when exchange-traded investment products (
Barclays Global Investors'
HOLDRs) are proliferating: Why not list an open-ended trust or mutual fund containing an actively traded Treasury security -- the most recently issued 10-year note, say. Shares in the trust or fund could represent a tenth of the $1,000 face value of the issue, or $100 if it was trading at par. Individual investors could buy and sell the shares to make relatively short-term bets on interest rates.
For example, someone who wanted to wager that Treasury yields were nearing a short-term high and that the release of the monthly
employment report would mark a turning point could buy Treasury shares the day before the report's release. If yields did in fact turn south as bond prices rose, the investor could capture the gain.
Of course, one could theoretically do the same thing using actual Treasury bonds, but it would have to be done on a much larger scale. And even in the Treasury market, which is very liquid compared to the other bond markets, it is difficult for individual investors to know what kind of price execution they're getting.
A liquid market is a market with loads of potential buyers. In that kind of market, you should be able to buy and sell quickly, at prices close to where the last trade took place. In a relatively illiquid market, like the municipal and corporate bond markets, the number of potential buyers for any given issue is smaller. As a result, dealers bid lower as compensation for the risk involved in holding a bond while looking for buyer for it.
Any number of Web sites can tell you the price and yield levels at which the most actively traded Treasuries traded in the last 15 minutes. But even if you have access to real-time Treasury quotes, those quotes are based on institutional-sized trades of typically $1 million face value or more. What's the right price for $250,000 worth? How about $10,000? These are the mysteries of the bond market.
The ability to transact Treasuries on an intraday basis with full price transparency "are things that are not available to the individual investor despite the liquidity of the Treasury market," says Lee Kranefuss, CEO of Barclays Global Investors' individual investor business.
Barclays is exploring the possibility of launching exchange-traded bond funds for other types of bonds, and its Canadian affiliate is seeking approval to launch products based on the five- and 10-year Canadian government bonds.
The prospects for exchange-traded bond funds based on corporate or municipal bonds are considerably dicier than the prospects for Treasury products. Keep in mind, we're talking about a kind of product different from a closed-end bond fund. Closed-end bond funds can be bought and sold throughout the day, but what's bought and sold are shares in a portfolio. The portfolio itself doesn't buy and sell assets to accommodate purchases and redemptions. That's why it's called closed-end.
The kind of product envisioned here would buy and sell assets as investors bought and sold shares. The prices at which investors bought and sold shares would be linked to the prices of the securities in the fund.
But there's the rub. In an illiquid market, there's no obvious way to calculate the value of the securities in the fund, as there is with stocks. Bond dealers have to report their transactions to regulators, but outside the Treasury arena, those trades are not disseminated on an intraday basis. A sponsor of an exchange-traded bond product could enlist a bond pricing service to calculate the fund's value throughout the trading day, but that would raise "a lot of technical and legal issues," says Gus Fleites, director of exchange-traded funds at
State Street Global Advisors
The Treasury arena doesn't present this problem, because it's a liquid market where securities are traded throughout the day and trade data is widely disseminated. So there's no reason it wouldn't work, Kranefuss and others say. But that doesn't make this type of product a slam dunk.
For one, something reasonably close to it already exists. Investors who want to speculate on interest rates through Treasury securities in a small way can buy and sell shares in
Target Maturities Trust
funds, which mimic the performance of zero-coupon Treasuries maturing in a particular year. The longer the maturity of the fund, the more sensitive its price to changes in interest rates. And a zero-coupon fund is far more sensitive to changes in rates than a fund containing ordinary, coupon-bearing issues would be.
Of course, as open-end mutual funds, the American Century funds don't let you jump in and out on an intraday basis. (Exchange-traded zero-coupon Treasury funds might be possible and could offer tax advantages, but among Treasuries, zero-coupon issues are somewhat liquidity-challenged.) But then you have to ask: How many small investors really want to do that? "You really have to question what kind of demand there would be for that kind of product," State Street's Fleites says. Most investors buy bonds for income, rather than to speculate on interest rates, he points out. "That kind of investor really isn't playing in the bond market." People who want to make more sophisticated bets "are already doing it," through either Treasuries themselves or Treasury futures.
Maybe, maybe not, says Gary Gastineau, managing director at
, who declines to say whether the firm is planning on introducing exchange-traded Treasury funds. "I think it's something that's certainly possible," he says. "You don't know how many customers there are for something till you bring it out and it's a real thing out there in the marketplace. My feeling is that something like that not only would work but would probably be an attractive product."
TSC Fixed-Income Forum aims to provide general bond information. Under no circumstances does the information in this column represent a recommendation to buy or sell bonds, funds or other securities.