The Bond Markets have been solidly in the news lately. All eyes are on the Treasury Notes and Bonds space to see where yields are headed and what is the Bond Market’s take on projected inflation. With so much happening in the Treasury bond markets right now, it is an opportune time to know and understand some of the alternatives available for fixed income investors in the ETF space.
Here are some Treasury ETFs for your consideration.
SHY or the iShares 1-3 Year Treasury Bond ETF (which has also been explained in the Treasury ETF Lecture) remains one of the largest and most popular Treasury ETFs with approx.. US$20bn in Net Assets as of March 22, 2021. However, given how low short term interest rates are today, the yield from investing on short tenor Treasury Bonds is next to nothing. Current YTM on the underlying Treasury Bond portfolio is approx. 19 basis points (or 0.19%). Last 12 months trailing yield was 70 basis points as of Mar 22, 2021. Management fee itself is 15 basis points.
If you look at the historical performance, you can see that the ETF performs really well when short term interest rates are on a downward trend. Remember Bond Prices move in opposite direction to Interest Rates! As the Fed started cutting rates from the end of 2018, SHY NAV increased in response to the rate cuts. When the Fed cut rates further in response to the Corona Virus pandemic in Feb and Mar 2020, the NAV rose even further to a high of almost US$87. (See Area marked in Red below)
One of the key points to note though is that the ETF is highly liquid. Average daily volume is almost 3mn shares. Given the highly safe nature of the underlying securities (i.e. short dated US Treasuries) and the ample liquidity in the ETF, bid-ask spreads are very low – approx. 1 basis point. In summary, this is the safest asset class one can invest in. The yield may be paltry, but you are assured that you investment is ultra safe – both from credit risk and interest rate risk.
Similar to SHY, VGSH or Vanguard Short Term Treasury ETF is also an ETF that primarily invests in short dated US Treasury Bonds, typically tenor of 1 – 3 years. The VGSH is also a large and popular ETF with net assets of approx. US$10bn as of 28 Feb 2021. Current YTM on the underlying portfolio is also 20 basis points, similar to SHY. However, one of the most important and key differences between the 2 ETFs is the management fees. VGSH has an expense ratio of 5 basis points compared to the 15 basis points of SHY. This can be highly significant especially when interest rates are so low and yield are negligible. You can see the 30 day SEC yield (a SEC mandated standard metric useful for comparing funds) is 4 basis points for SHY and 11 basis points for VGSH (Data as of 23 Mar 2021).
Once again, similar to SHY, you can see that since the ETF is essentially an exposure to short dated US Treasuries, the NAV climbs higher when short term rates are trending down.
Lets switch gears and look at some long tenor bond ETFs. TLT or the iShares 20+ Year Treasury Bond ETF is amongst the largest ETFs that cater to the long end of the Treasury curve. Key points –
Net Assets = US$14.7Bn
Avg. YTM = 2.42%
Effective Duration = 18.43 Years
Fees = 15 basis points
12 month Trailing Yield = 1.66%
(Data as of 23 Mar 2021)
Here is a quick look at the last 10 year NAV history chart. As you can see the ETF NAV has almost doubled over the past 10 years. Fixed Income has had a phenomenal bull run over the last few decades on the back of ever reducing interest rates. Decades of unconventional monetary policy across the globe has created an endless demand for US Treasuries. And most importantly inflation has noticeably been absent causing many to question the success of this monetary policy. However, what has been transpiring over the last few months in the bond markets is intriguing. The yield of the 10 Year US Treasury has increased from 0.9% to 1.65% in the first 3 months of 2021. Notice the area marked in red in the chart below. The TLT ETF price has fallen from a high of US$171 to $136 (as of March end 2021). Due to the high Duration, the ETF is highly sensitive to changes in interest rates and inflation expectations. The question to ponder upon is when does the Fed start getting uncomfortable with the rise in the longer end of the rate curve. Till the economy and more importantly the capital markets show no sign of distress from the rising rates, the Fed will choose to stay neutral. But when things get a little out of hand, will the Fed increase its monetary easing measures and start buying more long tenor Treasury Bonds and press down yields as a part of its Open Market Operations?
To know more about the US Treasury market, it size and scope, nuances, analysis of Treasury securities ownership and many such interesting topics, take our Fixed Income Analysis course and watch the video at the below link!