Can Flight To Safety Save These Treasury Bond ETFs?
The bond market behaved in a peculiar manner when it started recording decline in yields across the yield-curve spectrum from December 17, just a day after the Fed hiked key interest rate after almost a decade. Agreed, the Fed move was largely expected and much of the meeting’s outcome was priced in before. Still, this time around, the bonds market did not act wild at all – especially the long-term bonds – as it did in taper-trodden 2013. On December 16 – the day the Fed announced the hike, the two-year benchmark Treasury yield jumped 4 bps to 1.02% – a five-and-a-half year high. The yield on the 10-year Treasury note rose just 2 bps to 2.30% and yield on the long-term 30-year bonds saw a 2-bps nudge to 3.02%. But yields on the benchmark 10-year Treasury bond fell 11 bps to 2.19% in the next two days accompanied by a 12-bps slump in 30-year Treasury bond, 5-bps dip in the two-year benchmark Treasury yield and a 7-bps decline in the ultra-short three-month benchmark Treasury yield. Why the Dip in Bond Yields? Investors must be looking for reasons why the bond market went against the rulebook, which says when interest rates rise, bond yields jump and bond prices fall. Several investors thought that the bull era of bonds will come to an end with the Fed tightening its policies. However, the Fed’s repeated assurance to go ‘gradual’ with the rate hike policies might have soothed bond investors’ nerves. Plus, while a healing job market strengthened the prospect of the next hike again in March 2016, a still-subdued inflationary backdrop led investors to mull over a near-term deflation possibility amid a rising rate environment. Added to this, global growth worries, the possibility of a scarier plunge in greenback-linked oil prices (as the U.S. dollar soars post Fed hike), weakening overall commodity market and possibility of lower U.S. corporate profits in the upcoming quarters might have propelled a flight to safety. Investors should also take note of the Fed funds rate projection. The estimated median funds rate was maintained at 0.4% for 2015 and 1.4% for 2016, while the same for 2017 and 2018 were lowered from 2.6% to 2.4% and 3.4% to 3.3%. The projected range for 2015, 2016 and 2017 was changed from negative 0.1-positive 0.9% to 0.1-0.4%, from negative 0.1-positive 2.9% to 0.9-2.1% and from 1.0-3.9% to 1.9-3.4%, respectively. All these show no material threat to long-term bonds and the related ETFs after the first Fed hike. 25+ Year Zero Coupon U.S. Treasury Index Fund (NYSEARCA: ZROZ ) This ETF follows the BofA Merrill Lynch Long US Treasury Principal STRIPS Index, which focuses on Treasury principal STRIPS that have 25 years or more remaining to final maturity. The product holds 20 securities in its basket. Both the effective maturity and effective duration of the fund is 27.22 years. This fund is often overlooked by investors as evident from an AUM of $158.5 million. The product charges 15 bps in annual fees and returned 2.1% on December 17, 2015. The fund is down 4.2% so far this year. The fund yields 2.70% annually and has a Zacks ETF Rank #2. Vanguard Extended Duration Treasury ETF (NYSEARCA: EDV ) For a long-term play on the bond market, investors have EDV, a fund that seeks to match the performance of the Barclays U.S. Treasury STRIPS 20-30 Year Equal Par Bond Index. This means that this benchmark zeroes in on fixed income securities that are sold at a discount to face value, and then the investor is paid the face value upon maturity. This particular 74 bond basket has an average maturity of 25.1 years. The effective duration of the ETF stands at 24.7 years, suggesting high interest rate risks. The fund has amassed about $371.1 million in assets. Investors should also note that this is a cheap product, as it charges just 12 basis points a year, so it will be a very low cost way to get into long duration bonds. The fund has lost about 5.4% in the year-to-date time frame on rising rate worries but gained 1.8% on December 17. This Zacks Rank #2 ETF yields 2.86% annually. iShares 20+ Year Treasury Bond (NYSEARCA: TLT ) This iShares product provides exposure to long-term Treasury bonds by tracking the Barclays Capital U.S. 20+ Year Treasury Bond Index. It is one of the most popular and liquid ETFs in the bond space having amassed over $5.7 billion in its asset base and more than 8.4 million shares in average daily volume. Its expense ratio stands at 0.15%. The fund holds 31 securities in its basket. The average maturity comes in at 26.65 years and the effective duration is 17.37 years. The fund gained over 1.1% on December 17. TLT has a Zacks ETF Rank #2 with a High risk outlook. Original Post