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Treasury Yield Trends, Alternative Yield & Long/Short Managers
August 16, 2017

Investors have been buying more long-term Treasury bonds and selling less since Dec 19, 2016 (blue vertical line), when the 30-year TSY bond yield peaked (plotted in black, TYX, top panel) in Figure 1. Investors are concerned the economy will slow while equity volatility and the rate of change on TYX yield has declined. Daily equity prices and bond yields have displayed rates of change that are well below the norm. Treasury yields and bond prices have been choppy, being up 30 to 50 bps and then down more frequently than the norm. The trends in U.S. equities and Treasury bonds have been the primary driver of why long/short managers have recorded low returns since January 1, 2016.

Figure 1. January 1, 2016 through July 31, 2017

The top panel of Figure 1 plots the Morningstar Hedge Fund Index ETF (HFs) and the IShares 20+ Year Treasury Bond (TLT) Exchange Traded Fund (ETF), which recorded cumulative total returns of 2.2% and 6.7%, respectively, from January 1, 2016 through July 31, 2017. The Arrow Insights Government Bond Strategy Index (AIGBD) gained 8.7%. In 2016, AIGBD had strong gains while HFs gained slightly through July 3, 2016 when the trend of TYX was strong and consistently down as TLT soared. The hedge fund index gained about 0.6% while TLT and AIGBD lost -14.2% and -3.9%, respectively, from July 3, 2016 through year-end 2016 as TYX’s yield soars from 2.1% to 3.2% on December 19-20, 2016.

Since December 20, 2016, TYX’s 21-day rate of change (ROC(21)) has zigged-zagged in the +8% to -9% range, which is well below the ROC evident in 2016 as its yield declined from 3.2% to 2.90%. The trend in TYX has been too choppy to profit from being long and short long-term TSY bond futures, which were the primary source of HF’s and AIGBD’s positive returns in 2016.

Long/short hedge strategies rely upon strong and consistent trends in long-term TSY bond prices and yield to harvest profits. Hedge strategies are less dependent upon strong equity markets because choppy bond prices are often associated with choppy currency and commodity markets that provide sources of return for HFs and managed futures funds (not shown). Long/short strategy returns will rise when the trend in TSY bonds trades in one direction consistently.

Investors can hedge their exposure to raising TSY rates with allocations to long/short HFs and alternative bond strategies. Investors can harvest more consistent returns through a mix of long/short strategies by weighting their alternative investment allocation with 50% to long/short hedge funds, 30% to managed futures and 20% to alternative long/short yield.

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