Shorting long term Bonds: Db X-Trackers II Short Iboxx Sovereigns Eurozone Total Retun Index ETF

I have put this ETF in my portfolio at 112,9 with the idea to double my position if it's price falls of another 4%-5%.

The reason is simple: the actual market phase which started in march 2009 presents a strong anomaly: normally when equity and High Yield bonds jump sovreing bonds suffer, because of the unwinding of the "fly to quality" and the subsequent huge transfer of liquidity between asset classes with different risks. This time around instead every asset class is rising in price... corporate IG and HY bonds, equity, sovreing bonds... like if a schizophrenic response is following the generalized plunge in assets prices of 4Q2008 and 1Q2009, which was equally abnormal and caused mainly by psicological reasons.

If in march the misprincing in equity seemed pretty clear, now the mispricing in european sovreing bonds is equally evident.
The market is betting on low inflation and a very low level of interest rates for a long time due to a weak recovery in the economic activity, while i consider more likely a solid rebound in economic activity and an acceleration of inflation in 2010-2011.

If in march the mispricing on equities seemed pretty obiouvs, now the mispricing on european sovereign bond seem almost as obiuvs.


As we can see from the graph european governemen bonds reached their cycle lows in mid 2008, a few months before the daflut of Lehman Brothers, when commodities reached record high prices and the European Central Bank was determined to fight inflation during a phase of high uncertainty for the european and world economy.

The gold period for these securities started after the failer of Lehman Borthers, thanks to central banks reducing interest rates and to a strong fly to quality on the stronger issuers (France and Germany), caused by a fears of a new great depression and deflation threats.

I don't know for how long the rise in the price of these securities can go on, but i know one thing: it can't go on forever.

After putting down the basic idea after the investment, let's take a look on the charateristics of the ETF.

In my opinion it's not an instrument adequate for long term investment, because it shorts a total return index (this means that the coupons are reinvested in the index). But i think that it can work for medium term investments of no more than 4-5 years, if used in a rational way.

To compensate the fact that it shorts a total return index the ETF is remunerated by an interst rate than is 2 times the EONIA interest rate minus the cost on management of the fund (0,15% of total asset under management).

The medium maturity of the securities that compose the index is 8 years, so it pretty sensible to the change in long term interest rates.

To confirm this we can look at the long term graph of the Iboxx short Eurozone index, Iboxx Eurozone Index and 8 y EUR yield benchmark:


Looking at the period between 2005 and mid 2008, during which the ECB raised interest rates, you can see a significant appreciation of the Iboxx short eurozone index.