There is no denying that 2014 has been a year to remember for fixed income exchange traded funds.
That much was on display in October when U.S. bond ETFs hauled in $17.7 billion in new assets, easily surpassing the monthly record set in February. On a global basis, bond ETFs have seen assets by $78.6 billion, or 22%, to $430 billion. [Bond ETFs Dominate October Inflows]
Add to that, BlackRock’s recently published 2014 U.S. Institutional ETF Usage Report highlighted bond ETFs as an area of increased ETF usage by institutional investors in 2015.
However, no bond ETFs can measure up to the PIMCO 25+ Year Zero Coupon US Treasury (NYSEArca: ZROZ) and the Vanguard Extended Duration Treasury ETF (NYSEArca: EDV) in terms of 2014 performance. ZROZ and EDV have posted an average year-to-date return of 46%. Put simply, ZROZ is the best-performing non-leveraged ETF of any type this year while just three ETFs, including ZROZ, have outpaced EDV.
With inflation expectations muted heading into 2015, EDV and ZROZ could be in for another strong year. EDV and ZROZ hold Treasuries where the coupon has been stripped out and those types of bonds are among the most vulnerable to inflation.
“Investors’ expectations for consumer-price increases are diminishing as the Federal Reserve debates how soon to raise its benchmark interest rate, which has been held close to zero since 2008 to support demand in the economy,” reports Susanne Walker for Bloomberg.
The Fed has been seeking 2% inflation but even with quantitative easing, U.S. inflation has missed the 2% goal for two and a half years, according to Bloomberg. If wage growth starts picking up as U.S. employers add more jobs next year, that could stoke inflationary pressures, making EDV and ZROZ vulnerable in the process.
Key to the 2015 outlook for EDV and ZROZ is the Fed’s timetable for raising interest rates. EDV has an effective duration of 25 years while ZROZ’s 27.2 years. EDV and ZROZ have already shown investors the risks of stripped coupons in rising rate environments. When Treasury yields spiked last year, EDV and ZROZ lost an average of 20.5%. [Why These Bond ETFs Have Surged]
PIMCO 25+ Year Zero Coupon US Treasury Index ETF
