Someone Made a Big Bet on Small ETF That Treasuries Rally On

  • Pimco zero-coupon ETF saw heavy volume before Yellen remarks
  • Fund attracted second most fixed-income ETF inflows this week

Less than two hours before U.S. Federal Reserve Chair Janet Yellen took center stage this week, an obscure exchange-traded fund managed by Pacific Investment Management Co. was the site of aggressive speculation on the rally in Treasuries.

Just before 1 p.m. in New York on Wednesday, the Pimco 25+ Year Zero Coupon U.S. Treasury Index ETF saw a $138 million block trade, representing more than 60 percent of the outstanding shares, according to data compiled by Bloomberg. It was a 30-fold increase over the average daily trading volume in a fund that’s structured to let investors wager on an asset class that does best when rates are falling.

The heavy buying in the ETF continued on Thursday, with two trades worth a combined $57 million coming before 11 a.m., Bloomberg data show.

“This was one of the few in the space that our algorithms identified as a good momentum play,” said Dan Jacoby, chief investment officer at Stratos Wealth Management, which oversees about $7 billion in assets and bought the ETF shares on April 29. “I see the momentum carrying it further for a while.”

With the Fed dialing back expectations of multiple rate increases this year and little sign of inflation, investors are searching for yield in longer-dated bonds. The longer the duration -- a measure of price sensitivity to changes in interest rates -- the more the debt has rallied. Zero-coupon bonds have become increasingly popular this year because they have a longer duration than similar-maturity notes as holders only get paid when it’s due instead of receiving interest payments throughout its life.

Rally Rise

“Zeros do well in a rally, always,” said George Goncalves, head of U.S. interest rates research at Nomura Securities. “They are a pure play on duration.”

The Pimco ETF, which goes by the ticker ZROZ, has gained roughly 22 percent this year, making it one of the best performing fixed-income funds in the U.S. This week it took in more cash than any fixed-income ETF in the country other than the $37.9 billion iShares Core U.S. Aggregate Bond fund, Bloomberg data show.

But it’s hardly the only zero-coupon ETF to rise in the rally. The $573 million Vanguard Extended Duration Treasury ETF follows a similar investment philosophy and is up 21 percent this year.

Using ETFs is increasingly popular among institutional investors who want stock market liquidity for assets that are hard to trade. The market capitalization of Pimco’s zero-coupon ETF rose to about $350 million this week, up from $218 million before the Fed meeting, data compiled by Bloomberg show. Almost $131 million of new shares were created on Wednesday.

However, some institutional managers are becoming leery about the fund’s rapid rise and whether it meets their needs at this price. Matt Papazian, chief investment officer at Cardan Capital Partners, uses the ETF to offset his firm’s equity position, but moved some of his hedge to another product at the beginning of the year -- and may cut further.

“We want to have exposure to these things at all times, we’re still there,” said Papazian, whose Denver-based firm manages around $530 million. “At this rate, we would probably reduce it again because the valuation is slowly but surely being eroded by this rapid increase.”

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