BMO’s $1.1 million leveraged notes on iShares 20+ Year Treasury Bond offer value play

By Emma Trincal

New York, Feb. 28 – Bank of Montreal’s $1.1 million of 0% market-linked securities – leveraged upside participation and one-to-one downside exposure due Aug. 23, 2027 linked to the iShares 20+ Year Treasury Bond ETF give Treasury bulls exposure to a rarely used underlying, which is trading at a record low price, a factor that should appeal to value investors, a portfolio manager said.

The payout at maturity will be par plus 145.5% of the gain in the ETF, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will have full exposure to losses.

Fed-related

“We’ve seen a few inquiries on TLT lately although you don’t see this one very often in a note,” said a sellsider.

“People expect lower rates. Since October rates have come down a lot. Of course, a lot of it has to do with Fed rate cuts expectations.”

The same driver may apply to long-term rates too.

“Even if the Fed mostly controls the short-end of the curve, its actions also have an impact on the long end,” the sellsider said.

Attractively priced

Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments, said he liked the notes because of the deeply discounted price of the underlying.

“There’s good value in this trade,” he said.

“The trade is a timely bet given how beaten up the price of TLT is right now.”

He said he has not seen notes linked to this ETF before.

“We should see more.”

The iShares 20+ Year Treasury Bond ETF (ticker: “TLT”) offers exposure to the price (not the yield) of long-term U.S. Treasury bonds.

In October, the 20-year Treasury yielded over 5.5%, its highest level since 2007.

As bond prices move inversely to yields, the ETF in October hit a 16-year low at $82.42.

“Obviously getting the leverage with unlimited return is a very good thing. On the risk side, I’m pretty comfortable with the one-to-one exposure. You don’t need the protection when you enter a trade at a record low price,” he said.

In the beginning of January 2020, the 20-year Treasury yielded less than 1%. Its current yield is 4.54%.

While many market participants will shy away from the unpopular ETF, Kaplan said it represents a buying opportunity.

Hedgers vs. speculators

Kaplan explained why he is bullish on Treasuries.

“The commercials have been heavy buyers especially since the summer,” he said.

“They set new records lately according to the COT reports.”

The term “commercials” refers to active participants in the futures market who enter positions for the conduct of their own line of business often for hedging purposes. Their trades have to be reported weekly to the Commodity Futures Trading Commission via Commitments of Traders (COT) reports.

Hedge funds entered short positions last summer in contrast with the commercials, he noted.

“That’s what hedge funds do. They tend to imitate each other. They crowd in at the top and they short at the bottom,” he said.

“The commercials on the other hand are familiar with the futures they’re trading. They know there’s no reason why long-term Treasuries should be so cheap. As contrarians, if they see hedge funds doing something stupid, they will take the opposite side,” he said.

Long-term play

The heavy bid from the commercials sparked a short-term rally in January. Another factor was the hedge funds covering their short positions, he said.

“When their positions move against them by 15% or 20%, the hedge funds cover. So, the short-covering pushed the price even higher,” he said.

This month, however, the share price dropped a little over 5%.

“It’s a combination of renewed inflation concerns and the shorts closing out,” he said.

“Also, the strong equity market may have led some people to abandon treasuries momentarily because bonds right now are boring,” he added.

But the trend is bullish and the tenor of the notes is long enough to give bondholders an opportunity for growth, he concluded.

“TLT is trading at record lows. It’s possible that by 2027, the share price may have hit a high point and start to come down. But your chances of getting a strong return, especially with the leverage, are reasonably high right now,” he said.

Wells Fargo Securities LLC is the agent.

The notes settled on Feb. 21.

The Cusip number is 06375MWR2.

The fee is 2.825%.

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