AGG iShares Core US Aggregate Bond

As by far the largest of the PIIGS economies, Italy occupies a special place among investors concerned about the euro zone crisis. That is why when the country’s benchmark 10 year notes saw spiking yields in late 2011 and early 2012, many panicked, assuming that spiking yields in Italy were a sign of things to come across the smaller, but equally troubled members of the common currency bloc. After all, while small markets such as Greece and Portugal can likely be contained by bailout funds and more capital from the ECB, a nearly two trillion dollar economy—Italy—could potentially take down the entire region, if not the broader world economy as well.

However, while bond yields briefly broke above the key 7% barrier, they have begun to slump back down below this key figure in recent days. In fact, yields are now approaching the 5.5% level, representing a huge slump in just a few weeks for payouts on these fixed income securities. With this drop, yields on Italian bonds are now at their lowest point since mid October of last year, possibly signaling that the European situation may at least be temporarily under control and that further gains could be had in the space (read Three bond ETFs For A Fixed Income Bear Market).  

While it may not be possible for most investors to directly invest in the Italian bond market, there are some relatively new Italian bond ETNs that can act as a good proxy for exposure.  These products, the PowerShares DB Italian Treasury Bond Futures ETN (ITLY) and the PowerShares DB 3x Italian Treasury Bond Futures ETN (ITLT) have both been star performers so far in 2012, far outpacing many of their broad based peers. Both funds—ITLY is unleveraged while ITLT tracks a 300% leveraged version of the same benchmark—track the performance of a long position in Euro-BTP Futures which are debt securities issued by the Republic of Italy. The funds have a focus on the middle part of the curve, offering exposure to securities that have a maturity of at least 8.5 years but no more than 11 years. This gives the products medium levels of duration risk ensuring that the funds will move, but will likely not see huge shifts in short periods of time (read Do You Need A Floating Rate Bond ETF?).

Both funds have, unsurprisingly, performed quite well over the past few weeks as slumping bond yields boost prices for these ETNs. ITLY has jumped by about 12.4% in year-to-date terms while the leveraged ITLT has added 33.5% over the same time period. While it is true many products have surged to start the new year, the gains in the bond space have been much harder to come by, making the returns of these Italian bond ETNs even more impressive. In fact, broad U.S. funds like AGG and BND have added less than 0.3% since the start of the year while EU, a fund that tracks bonds from across Europe, has gained just 4.5% in comparison, Clearly, Italian bonds have been the place to be to start the year and could continue to gain if sentiment remains high over the PIIGS nations (see The Best Bond ETF You’ve Never Heard Of).

With that being said, investors should note that briefly in early December of 2011 yields fell to right near their current level. This represented a quick drop from near 7.25% rates but yields soon came back to hit the 7% level after just a few weeks. This situation could once again happen this time around, although it should be noted that the decline in yields has already been smoother this time than it was in December, suggesting more staying power in this iteration. As a result, if investors are looking to make a play on the Italian bond market, they must definitely weigh their options. The country’s bonds could certainly continue to see falling yields which would be more great news for products like ITLY and ITLT. However, if Greece remains shaky and if investors continue to fear more turmoil across the bloc, it wouldn’t be unreasonable to see all of the gains that the ETNs have seen so far this year evaporate in short order, suggesting that only investors with high risk tolerance and the desire to trade frequently should consider making a play on these uncertain products (also see EUFN: The Best ETF For The Euro Crisis).

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