Best Performing ETF Group is Not What You Think

With just two months to go in 2022, the best-performing group of Exchange Traded Funds year-to-date may not be what you would have expected it to be when we started the year.

After a strong bull market rally coming off the march 2020 Covid-19 dip, most investors would have assumed stocks, mainly big technology stocks, would again be the market leaders in 2022.

However, the market never ceases to surprise, and as hindsight is always in 20-20 vision, it feels like we all should have seen the signs that 2022 wasn't going to be a good year for stocks and another asset class was going to dominate.

What asset class are we speaking of? Bonds! Well, to be more specific, shorting Treasury Bonds.

Shorting longer-dated Treasury bonds has been, hands down, the best trade of 2022. Whether you use leveraged and-or inverse products or not, shorting Treasury Bills has produced great results in 2022.

For example, the ProShares UltraPro Short 20+ Year Treasury ETF (TTT) is up 176% year-to-date and more than 50% over the last three months. Direxion's version of the same ETF, the Direxion Daily 20+ Year Treasury Bear 3X Shares ETF (TMV), is also up 176% year-to-date. The ProShares UltraShort 20+ Year Treasury ETF (TBT), which is a 2X leveraged inverse fund, is up more than 100% year-to-date.

Even the funds that short the shorter term Treasury bills, the 7-10 year term bills, like the Direxion Daily 7-10 Year Treasury Bear 3X Share ETF (TYO) and the ProShares UltraShort 7-10 Year Treasury ETF (PST) are up 66% and 42% respectively.

If you had run a screener at the beginning of the year for non-leveraged and non-inverse funds because the risk involved with those products are not necessarily in your comfort zone, you still could have bought the Simplify Interest Rate Hedge ETF (PFIX). PFIX holds over-the-counter interest rate options and US Treasury Inflation-Protected Securities or TIPS, and still produced a return of around 100% year-to-date.

So you may be asking how and why shorting longer-dated Treasury bills produce solid results when interest rates, Treasury bills, and bond yields are climbing higher. Well, it is a little complicated on the surface but pretty simple once you understand how it all works.

First, let us think about it this way. You have owned a 10-year Treasury bill for three years, paying you 2.5% interest. In this scenario, interest rates are lower than when you bought the bill; let's say the current 10-year bill is paying 2.00%. Your Treasury bill would be worth more than a current bill because your bill is paying a higher interest rate than what an investor could get if they bought a new one. In this situation, your Treasury bill increases in value as interest rates go lower since it pays a higher rate than what another investor could get otherwise.

In the second scenario, similar to what is currently happening in the bond market, you again hold a 10-year Treasury bill paying a 2.5% rate. However, rates are increasing. Thus, a recent 10-year Treasury bill is paying, let's say, 3.00%. Since an investor looking for a 10-year Treasury bond can get a 3% return on a new bill, the value of your bill, which is only 2.5%, will be lower than what you paid for it.

As interest rates and Treasury yields increase, the value of your bill will continue to decline since investors can get a better yield if they buy more recently issued Treasury bills. All of the ETFs mentioned above are using this phenomenon to their benefit. They are all shorting the value of the longer-dated 20, 10, and 7-year Treasury bills, which are paying lower interest rates than what investors can get with the newly issued Treasury bills.

Furthermore, if the Federal Reserve continues to increase interest rates as a way to fight inflation, we will continue to see the value of older, longer-dated Treasury bills decline. However, even if the Fed begins to slow or even stops increasing interest rates in the coming months, the ETFs mentioned above will likely continue to produce solid returns as long as we don't see interest rates rapidly decline.

If you are considering buying one of these products today, remember past performance is no guarantee of future results and that you may have missed the bulk of the trade on this one. Still, no one knows how high the Fed will be willing to push interest rates as it attempts to bring down inflation.

Matt Thalman Contributor
Follow me on Twitter @mthalman5513

Disclosure: This contributor did not hold a position in any investment mentioned above at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from for their opinion.