Margin Account Arbitrage

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Oct 31st, 2013 7:38 am

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Oct 29th, 2013 9:00 am

dgodsell [OP]: Deal Addict; Jun 6, 2007; 1025 posts; 139 upvotes; KINGSTON, Ontario

Oct 29th, 2013 9:00 am

Margin Account Arbitrage

I'm slowly selling off equity stakes; with excess capital available and a disinterest in holding cash I'm thinking about increasing exposure to bonds.

A boring but sensible option is to simply purchase a bond ETF, and my preferred fund is CBO, a 1-5 year laddered AAA-A corporate bond fund yielding 4.34%. I could spice it up a bit by buying XHY (junk bonds) which is yielding 5.7%. Half and half would yield approximately 5%.

My margin rate from Interactive Brokers is 2%. A risky strategy would be to leverage and purchase the 5%-yielding portfolio above and clear the 3% spread.

Duration and maturity of the bond portfolios above (CBO and XHY) are low (e.g. 3-4 years) so interest rate risk could be acceptable assuming a short-medium term holding period (i.e., 1-3 years).

What other risks characterize this strategy?

16 replies

Oct 29th, 2013 10:04 am

dlhunter: Deal Fanatic; Jun 27, 2007; 5507 posts; 1956 upvotes

Oct 29th, 2013 10:04 am

think about it. interest rates at record lows, bonds at record highs. as soon as the fed removes support, bonds will crash.

Oct 29th, 2013 2:08 pm

Mark77: Banned; Feb 15, 2008; 26318 posts; 3237 upvotes; Calgary

Oct 29th, 2013 2:08 pm

dlhunter wrote: ↑think about it. interest rates at record lows, bonds at record highs. as soon as the fed removes support, bonds will crash.

You could say the same about US equities as well. But I agree, at this point in the cycle, one would probably want to find companies that tend to be inversely correlated to low interest rates. US equities tend to be, as a group, poor for this, as are bonds in general.

TodayHello wrote: ↑...The Banks are smarter than you - they have floors full of people whose job it is to read Mark77 posts...

Oct 29th, 2013 2:29 pm

dlhunter: Deal Fanatic; Jun 27, 2007; 5507 posts; 1956 upvotes

Oct 29th, 2013 2:29 pm

Mark77 wrote: ↑You could say the same about US equities as well. But I agree, at this point in the cycle, one would probably want to find companies that tend to be inversely correlated to low interest rates. US equities tend to be, as a group, poor for this, as are bonds in general.

Equities are bubblicious too, one should look at alternative investments that were beaten down, like gold (just not miners). Fed seems to be the only buyer right now, as when they taper, rates will spike. Of course, something has to force them to act, like high inflation.

Oct 29th, 2013 2:47 pm

Psycho44: Deal Addict; May 28, 2006; 2389 posts; 181 upvotes

Oct 29th, 2013 2:47 pm

once my MBNA credit card comes in the mail my strategy for hedging the IB margin account will be dividend stocks. Got a few near 10% yield that I'm comfortable with.

Oct 29th, 2013 3:21 pm

dgodsell [OP]: Deal Addict; Jun 6, 2007; 1025 posts; 139 upvotes; KINGSTON, Ontario

Oct 29th, 2013 3:21 pm

From the news today and earlier this month it reads as though interest rates aren't heading anywhere for awhile; e.g. until 2015. The new Fed chair has suggested she won't raise interest rates until wages rise - rather than when unemployment drops. Bill Gross (PIMCO) has suggested that we should bet against interest rate increase sin 2015 and 2016, and that we may see low interest rates for decades to come.

In this state of the world, bonds do not look threatened.

I would suggest that my proposal is to do as the banks do: borrow low and invest in higher-yielding assets.

Oct 29th, 2013 3:41 pm

sunshinemoonlight13: Deal Addict; May 17, 2013; 1775 posts; 279 upvotes

Oct 29th, 2013 3:41 pm

dlhunter wrote: ↑look at alternative investments that were beaten down, like gold (just not miners)

Why do you say that? I agree by the way. Just want to hear your reason.

Mark prefers gold mining companies over gold bullion, even though the latter beat the former over the past 10 years.

Oct 29th, 2013 3:43 pm

sunshinemoonlight13: Deal Addict; May 17, 2013; 1775 posts; 279 upvotes

Oct 29th, 2013 3:43 pm

dgodsell wrote: ↑From the news today and earlier this month it reads as though interest rates aren't heading anywhere for awhile; e.g. until 2015. The new Fed chair has suggested she won't raise interest rates until wages rise - rather than when unemployment drops. Bill Gross (PIMCO) has suggested that we should bet against interest rate increase sin 2015 and 2016, and that we may see low interest rates for decades to come.

In this state of the world, bonds do not look threatened.

I would suggest that my proposal is to do as the banks do: borrow low and invest in higher-yielding assets.

Trying to predict what a few academic guys in an ivory tower will do is a losing proposition -- like owning shares in a gold mining company instead of physical gold over the long run.

By the way, why would you ever listen to what Bill Gross has to say about bonds? Shouldnt you take what he says with a grain of salt? I mean, he is 100% invested in the bond business. Its like trusting a used car salesman.

Oct 29th, 2013 3:44 pm

Mark77: Banned; Feb 15, 2008; 26318 posts; 3237 upvotes; Calgary

Oct 29th, 2013 3:44 pm

dgodsell wrote: ↑From the news today and earlier this month it reads as though interest rates aren't heading anywhere for awhile; e.g. until 2015. The new Fed chair has suggested she won't raise interest rates until wages rise - rather than when unemployment drops. Bill Gross (PIMCO) has suggested that we should bet against interest rate increase sin 2015 and 2016, and that we may see low interest rates for decades to come.

Doubtful. Sounds like the sort of comments you'd see at the top of a mania, that things will last forever. "stock prices will remain permanently elevated", famous words of somebody in the late 1920s. Interest rates are always cyclical. They have not repealed the business cycle.

In this state of the world, bonds do not look threatened.

I'd suggest quite the opposite.

TodayHello wrote: ↑...The Banks are smarter than you - they have floors full of people whose job it is to read Mark77 posts...

Oct 29th, 2013 3:46 pm

Mark77: Banned; Feb 15, 2008; 26318 posts; 3237 upvotes; Calgary

Oct 29th, 2013 3:46 pm

sunshinemoonlight13 wrote: ↑Why do you say that? I agree by the way. Just want to hear your reason.

Mark prefers gold mining companies over gold bullion, even though the latter beat the former over the past 10 years.

In a diversified portfolio with an emphasis on asset classes and assets inversely correlated with interest rates, there's room for both miners as well as bullion (or more generally, physical commodities -- doesn't have to be just gold). I'd also add firms that own good long-term infrastructure and have a decent amount of long-term debt to the list of desirable companies to own in a rising rate environment.

TodayHello wrote: ↑...The Banks are smarter than you - they have floors full of people whose job it is to read Mark77 posts...

Oct 29th, 2013 3:51 pm

sunshinemoonlight13: Deal Addict; May 17, 2013; 1775 posts; 279 upvotes

Oct 29th, 2013 3:51 pm

Mark77 wrote: ↑ physical commodities -- doesn't have to be just gold).

Physical silver.

You are all talk anyway. You said before you think its a waste of money to be buying physical anything. You prefer paper assets. So you will not be buying physical commodities either.

Oct 29th, 2013 4:16 pm

Mark77: Banned; Feb 15, 2008; 26318 posts; 3237 upvotes; Calgary

Oct 29th, 2013 4:16 pm

sunshinemoonlight13 wrote: ↑Physical silver.

You are all talk anyway. You said before you think its a waste of money to be buying physical anything. You prefer paper assets. So you will not be buying physical commodities either.

As I've told you, I don't think you're going to do well hedging an end-of-the-world scenario with physical gold or silver, versus guns, ammo, and rations. Therefore, I prefer physical assets such as miners, telecoms, pipelines, instead to take advantage of rising interest rates.

TodayHello wrote: ↑...The Banks are smarter than you - they have floors full of people whose job it is to read Mark77 posts...

Oct 29th, 2013 4:20 pm

sunshinemoonlight13: Deal Addict; May 17, 2013; 1775 posts; 279 upvotes

Oct 29th, 2013 4:20 pm

Mark77 wrote: ↑As I've told you, I don't think you're going to do well hedging an end-of-the-world scenario with physical gold or silver, versus guns, ammo, and rations. Therefore, I prefer physical assets such as miners, telecoms, pipelines, instead to take advantage of rising interest rates.

As I've told you, you don't understand the gold investment.

Not everyone who buys gold is a doom and gloomer.

Central banks are one of the biggest buyers of gold. Are they a bunch of doom and gloomers? The answer is no, in case you were wondering.

Oct 29th, 2013 6:11 pm

Mark77: Banned; Feb 15, 2008; 26318 posts; 3237 upvotes; Calgary

Oct 29th, 2013 6:11 pm

sunshinemoonlight13 wrote: ↑As I've told you, you don't understand the gold investment.

Not everyone who buys gold is a doom and gloomer.

Central banks are one of the biggest buyers of gold. Are they a bunch of doom and gloomers? The answer is no, in case you were wondering.

Historically the performance of gold bullion has been terrible, and it does not seem prudent to borrow money and concentrate into one asset class or even one asset.

TodayHello wrote: ↑...The Banks are smarter than you - they have floors full of people whose job it is to read Mark77 posts...

Oct 29th, 2013 10:29 pm

sunshinemoonlight13: Deal Addict; May 17, 2013; 1775 posts; 279 upvotes

Oct 29th, 2013 10:29 pm

Mark77 wrote: ↑ it does not seem prudent to borrow money and concentrate into one asset class or even one asset.

Another hypocritical statement. Yet that is exactly what you are doing. Using leverage to invest in XIU.TO and gold mining companies.

It is not prudent to be in debt period. It often never ends well. Whether that is for an individual, a corporation, a town, a state, or even a country.

Oct 29th, 2013 11:55 pm

SkimGuy: Deal Fanatic; Jun 19, 2009; 6133 posts; 1980 upvotes; Scarborough

Oct 29th, 2013 11:55 pm

Are you two going to turn every topic into a mini discussion about how you have differing views on certain asset classes? Can you not take this to Private messages as to not clutter up and derail every thread on the investing subforum?

Thanks in advance.

+1

Oct 31st, 2013 7:38 am

dgodsell [OP]: Deal Addict; Jun 6, 2007; 1025 posts; 139 upvotes; KINGSTON, Ontario

Oct 31st, 2013 7:38 am

The investment I'm considering for this strategy is CBO - a 1-5 year laddered bond ETF. I notice that the price varied only little when tapering was announced in June - I infer from this that the duration is so short as to be fairly robust from changes in interest rates.

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