Just how crazy are risk parity investors that are leveraging negative real yielding treasuries? A thread:

1/ The current interest rate environment is atrocious from a yield perspective with treasuries having a negative real yield:

2/ So why would anyone buy treasuries or "worse yet" go levered long treasuries at these yields? Let's dig into the mechanics of treasury returns and leveraged investing.

3/ The first component is the yield - So for a negative 1% real treasury yield, unfortunately, we have to start in the hole by 1%...not a great start!

4/ However, 5 year real treasury rates are even more negative!

5/ This means that if the yield curve is unchanged, the investor in the 10 year TIP gets some capital appreciation as the yield goes more negative. This can work even if interest rates rise by less than what is implied in the yield curve! This is called "roll down return".

6/ Moving from a negative 1% real yield to a negative 1.3% real yield adds about 0.5% per year of return from roll down return. We are not at "only" a negative 0.5% real return now!

7/ The next (and final) component is the act of leveraging the 10 year bond or shorting cash to buy the bond. Let's assume that the risk parity investor is going 2x long, so the risk parity investor owns the TIPs bond outright then shorts cash and buys the bond again.

8/ So the investor now earns the spread between the 10 year TIPSs and cash. If cash is at a negative 1.5% real return and is short and then buys the 10 year TIPs again at negative 0.5% return, the risk parity investor earns the spread or 1%.

9/ So when this is all added up, the risk parity investor earns a negative 0.5% from the bond outright and a positive 1% on the spread between cash and the bond again from the leverage...for a total positive return of 0.5%!

FIN/ Not that this is optimal or even the right thing to do, but it is important to understand the mechanics of a fairly complex strategy as the results can be somewhat un-intuitive.