In examining 2011 returns among bond exchange traded funds, we would wager that most industry participants would be surprised to learn that funds tracking “STRIPS,” zero coupon bonds issued by the U.S. Treasury, have generated some of the best performance year to date.
In fact, returns have been staggering to say the least in the space, with PIMCO 25+ Year Zero Coupon U.S. Treasury (NYSEArca: ZROZ) rallying 45.6% while Vanguard Extended Duration Treasury (NYSEArca: EDV) is up 42.3%.
ZROZ tracks the Bank of America Merrill Lynch Long Treasury Principal STRIPS Index, which is composed of the final principal payments (or STRIPS) of U.S. Treasury bonds with maturities greater than or equal to 25 years.
EDV on the other hand is based on the Barclays Capital U.S. Treasury STRIPS 20-30 Year Equal Par Bond Index, and is tied to the returns of U.S. Treasury STRIPS that have maturities in the 20 to 30 year range.
A STRIP refers to a single coupon or principal payment on a U.S. Treasury Bond that has been separated from the entire bond issue itself and is allowed to trade as a separate security on its own right.
Typically, returns on STRIPS are not as historically volatile as they have been in 2011, nor have they historically displayed the potential to generate such out-sized returns, but the current interest rate environment and Fed actions (or inaction) has to a large extent, made this possible.