Off-the-Run Treasuries

Off-the-Run Treasuries refer to U.S. Treasury securities that are no longer the most recently issued in a particular maturity range. Contrary to On-the-Run Treasuries, which are the most recently issued benchmark securities, Off-the-Run securities are older issues that were once the benchmark but have since been surpassed by newer issues.

Understanding Off-the-Run Treasuries

When the U.S. Department of Treasury issues a new security within a particular maturity range (e.g., 2-year, 5-year, 10-year), this new security becomes the On-the-Run security. Each new issuance supersedes the previous one. Once a new issue is introduced, the older security of the same maturity transitions to Off-the-Run status.

Characteristics

  1. Liquidity: Off-the-Run treasuries typically experience lower trading volumes and hence are less liquid than their On-the-Run counterparts. Liquidity determines how quickly and easily a security can be bought or sold in the market without significantly affecting its price. Due to lower liquidity, Off-the-Run treasuries may have wider bid-ask spreads compared to On-the-Run securities.

  2. Yield: Investors often find that Off-the-Run treasuries offer slightly higher yields to compensate for their lower liquidity. This yield differential is often referred to as the liquidity premium. Investors seeking slight yield enhancements might prefer these securities, assuming they can accept lower liquidity.

  3. Price Sensitivity: Because Off-the-Run treasuries have been in the market for a longer period, they may display different price sensitivities to interest rate changes compared to On-the-Run securities. This is mainly influenced by differences in trading volumes, market participants’ preferences, and the overall perception of these securities.

  4. Availability: The availability of Off-the-Run treasuries is determined by the initial size of the Treasury issues and their circulation in the secondary market. Since these securities are older issues, there might be times when finding a particular Off-the-Run security can be challenging, especially if a significant portion of the issue has been locked into buy-and-hold portfolios.

Utilization in Portfolios

Institutional investors, hedge funds, and sophisticated individual investors often include Off-the-Run treasuries in their portfolios for various strategic reasons:

  1. Yield Enhancement: Given that Off-the-Run treasuries typically offer higher yields than their On-the-Run counterparts, they can provide a yield-enhancement strategy for fixed-income portfolios.

  2. Arbitrage Opportunities: Market participants, particularly hedge funds, might leverage arbitrage strategies between On-the-Run and Off-the-Run treasuries. These arbitrage trades often capitalize on the price differences and yield spreads between the two securities.

  3. Diversification: Off-the-Run treasuries might behave differently compared to On-the-Run securities during certain market conditions, offering additional diversification benefits within a fixed-income portfolio.

  4. Hedging: Some investors use Off-the-Run treasuries to hedge against specific risks in their portfolios, including interest rate risks and liquidity risks.

Off-the-Run Treasury Pricing Mechanism

The pricing of Off-the-Run treasuries in the secondary market involves several factors, including:

  1. Market Demand and Supply: The price is influenced by the current demand for and supply of the specific security in the market.

  2. Yield Curve Changes: Changes in the overall yield curve can impact the price of Off-the-Run treasuries.

  3. Credit Risk and Default Risk: U.S. Treasury securities are generally considered free of credit and default risks; however, market perceptions can influence the pricing.

  4. Institutional Holdings: Large institutional holdings of a specific Off-the-Run security can reduce market availability and influence pricing.

Trading Off-the-Run Treasuries

Trading Off-the-Run treasuries requires a different approach than trading On-the-Run securities, primarily due to the differences in liquidity and market activity.

Trading Platforms

Trading of Off-the-Run treasuries can be conducted through various platforms:

Tradeweb: Tradeweb Bloomberg: Bloomberg

Market Participants

Market participants in Off-the-Run treasury markets include:

Risks Associated with Off-the-Run Treasuries

Despite their benefits, Off-the-Run treasuries carry specific risks that investors must consider:

  1. Liquidity Risk: The lower liquidity of Off-the-Run treasuries can pose challenges when attempting to buy or sell large quantities without significant price changes.

  2. Market Risk: Off-the-Run treasuries are still subject to interest rate risks and overall market risks, similar to other fixed-income securities.

  3. Opportunity Cost: The potential for slightly higher yields must be weighed against the opportunity cost of holding less-liquid securities, especially during market stress or liquidity crunches.

Conclusion

Off-the-Run Treasuries play an essential role in the U.S. Treasury market landscape, offering opportunities for yield enhancement, diversification, and hedging to sophisticated market participants. Understanding their characteristics, trading mechanisms, and associated risks is crucial for effectively incorporating these securities into investment and trading strategies. Though they may present challenges, particularly around liquidity and pricing, the benefits provided by Off-the-Run treasuries make them a valuable addition to many fixed-income portfolios.

For investors aiming to maximize their returns while managing risks, a thoughtful approach to including Off-the-Run treasuries can help achieve a well-balanced, resilient portfolio, capable of navigating various market conditions.