ProShares Juices Up Junk and Investment Grade Bonds

If you are not pleased with the current yield and price appreciation potential available from traditional investment grade and high yield bond funds, then the new leveraged ETFs from ProShares may just be the ticket.  The ProShares Ultra High Yield (UJB) and ProShares Ultra Investment Grade Corporate (IGU) ETFs began trading yesterday (4/14/2011), targeting twice the daily performance of both price and yield of their benchmarks.

IGU has an “effective yield” of more than 9% and UJB's exceeds 13%.  However, before you run out and commit a large chunk of your assets to these funds, you need to understand these ETFs also carry 200% the daily risk of non-leveraged funds.  Bonds lose money when interest rates rise, and leverage will amplify those loses.

For investors and traders that understand the double-edged sword of leveraged daily returns, these new ETFs should provide highly desirable additions to your tool belts.  If you do not fully understand the mathematics of daily compounding, then do not let the prospects of fat juicy yields entice you into something prematurely.  To gain an understanding, the ProShares document Geared Investing: An Introduction to Leveraged and Inverse Funds (pdf) is a good place to start.

ProShares Ultra High Yield (UJB) seeks daily investment results, before fees and expenses, that correspond to twice (200%) the daily performance of the Markit iBoxx $ Liquid High Yield Index, a modified market-value weighted index of U.S. high yield corporate bonds.  The underlying index currently has 415 constituents, a modified adjusted duration of 3.7 years, and an average yield to maturity of 7.20%.

Subtracting out the 0.95% expense ratio implies that UJB will have an “effective yield” of about 13.45%.  The fund gets its desired exposure by holding swaps tied to the daily total return performance of the iShares iBoxx $ High Yield Corporate Bond Fund (HYG).  Additional information is located in the UJB overview and UJB prospectus.

ProShares Ultra Investment Grade Corporate (IGU) seeks daily investment results, before fees and expenses, that correspond to twice (200%) the daily performance of the Markit iBoxx $ Liquid Investment Grade Index, a modified market-value weighted index of U.S. investment grade corporate bonds.  The underlying index currently has 763 constituents, a modified adjusted duration of 7.1 years, and an average yield to maturity of 5.05%.

Subtracting out the 0.95% expense ratio implies that IGU will have an “effective yield” of about 9.15%.  The fund gets its desired exposure by holding swaps tied to the daily total return performance of the iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD).  Additional information is located in the IGU overview and IGU prospectus.

Investors will not see the yield from these ETFs in the form of a monthly dividend.  Instead, the derivative contracts (swaps) held by the funds are priced to reflect the yield as part of their daily return calculation.  UJB & IGU target a return of 200% of the total return (price and accrued yield return) of their respective benchmarks for a single day.  Due to the compounding of daily returns, returns over longer periods will not be directly proportional to the returns of the underlying benchmarks.

Disclosure covering writer, editor, and publisher:  No positions in any of the securities mentioned.  No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.