You earn the total return when you buy and hold a real bond or a bond ETF. By contrast, bond futures are financed instruments, so you earn the excess return (total return MINUS financing cost). So all else equal, futures will ALWAYS perform worse than a bond, because of the drag from the financing cost (unless the financing rate is negative, which is happening in some parts of the world).
This may sound bad for futures, but it’s actually really easy to address. When you buy futures, you save a lot of cash since the margin requirement is minimal; if you invest that cash and earn a return on it, and attribute the return back to the futures, you’re basically back to earning the full total return again. This is known as “fully collateralizing” your futures. The question is, will the return you earn on cash be enough to offset futures’ implied financing costs?
In the buy ETF scenario you give up your cash and in turn get the bonds and earn their carry (less a management fee). In the buy future scenario you are not using much cash, but then you are giving up almost all of the return from the bond(s) in exchange for someone to finance them for you.
You are paying the market the repo rate to finance the underlying bond(s) for you. If the implied repo rate for the cheapest to deliver is < the 3 month bill rate (what you could invest the cash in), you are better off with the future.
You also save the withholding / dividend tax from holding the Bond ETF vs the hybrid rate of futures.
The bond ETF is the equivalent of holding the entire basket of bonds bought with your cash. You pay a management fee to the ETF sponsor for that privilege. The fees are small, usually around 15bp, but you need to be aware of them
You will have to roll the futures contract, which is annoying and can make you lose a few bp here and there in transaction costs.
Bond futures on CME:
Corporate bonds: None (Eurex contract is illiquid).
- TU: 2 yr Tsy
- FV: 5 yr
- TY/ZN: 10 yr (6.5-10 yr)
- TN: Ultra 10 yr (really targeted duration around 10 year).
- ZB: 15-25 yr
WN: Ultra Treasury bond: > 25 yr
Process:
- Check funding difference
- Check correlation daily and monthly last 5 years