Bond exchange traded funds (ETFs) are a great alternative to a simple bond investment, and the number of choices in bond-related funds is endless. Treasury ETFs have become a favorite safe-haven as investors look to protect their assets, so much so that it’s been pushing already paltry yields down to almost nothing. Despite that, don’t be so quick to dismiss an allocation to Treasuries for your clients.
Treasuries have been on a roller coaster ride this year. In the first quarter, belief in a sustainable economic recovery led to more equity investments and fueled fears of inflation, resulting in the 10-year note’s yield breaking above 4% for the first time since October 2008.
By late April, though, that momentum was shattered in the wake of the eurozone fiscal fallout and cautious investors poured more money into U.S. government debt, pushing yields to lows not seen since April 2009. The argument for owning Treasury bonds is that the economic recovery may be slow going at best. But even in that kind of an environment, the protection offered may be short-lived.
Fiscal tightening makes it more likely that the Federal Reserve and the European Central Bank, among others, will keep short-term interest rates near rock bottom for a while. This is presenting a fertile environment for investors and providers to offer and seek out Treasury bond funds. Long-term bonds rose quickly after bond traders were betting on long-date issues doing better than short-term bonds in a low-growth and low-inflation environment.
Still, inflation is crawling at a annualized rate of about 1%, consumers aren’t spending as much as they used to and the housing market is still flat, at best. All of this means that, at least in the short-term, Treasury bond ETFs may remain an appealing spot for investors to safely park their cash despite those low yields.
Additionally, the idea that we may be in a deflationary period, or in an environment of persistent declining prices, could also mean that low interest rates may be here to stay for the time being. This would benefit longer-dated Treasuries over those offered with short-term maturities. During deflationary conditions, fixed-income investments also tend to perform better than overall stocks.
There are additional benefits of Treasury bonds and Treasury bond ETFs, including:
- Treasury bond ETFs hold a basket of such bonds that would be cost-prohibitive to purchase individually. Many of these ETFs hold hundreds, if not thousands, of bonds.
- Treasury bonds are one of the safest bond types. There is always some risk in any investment, but Treasuries have long been considered about as safe as it gets.
- Treasury bonds are taxable at the federal level, but they’re exempt from state and local taxes.
- The relative security of Treasury bond ETFs means that they can offer a measure of stability to a portfolio in volatile markets.
There are around 29 Treasury bonds of various types – long, short, leveraged, inverse. When we sort by yield using the ETF Analyzer, the results reveal yields that are comparable, if not better, than what the individual bonds are giving out.
There’s one risk that looms large for Treasury bonds, though. When the Federal Reserve raises interest rates, long-term bonds may get hit. Be prepared and ready to act accordingly. Bond prices rise when interest rates fall, and the impact is magnified in long-term bonds than it is in short-term issues.
Currently, observers of the bond market are concerned about the possibility of a bubble forming, leaving trillions of safe-haven dollars at high risk. If the bubble does burst, there are a number of factors that can lead up to this scenario, including the return of inflation, the aforementioned rising interest rates, doubts about an economic recovery, and panic selling.
By understanding the risks and rewards of Treasury bonds, you can help get your clients the best type of exposure to these ETFs and manage their exposure to those risks accordingly. As a pro subscriber, you have access to unlimited trading alerts, which you can set up to be notified of a trading opportunity.