Laggards can become leaders and leaders can morph into laggards. The latter scenario is afflicting two of last year’s top-performing fixed income exchange traded funds.
Conventional wisdom dictates that as Treasury yields rise, longer-dated, high duration bonds, and the funds that hold those bonds, are more vulnerable to those rising yields than their low duration counterparts. Ten-year Treasury yields surging almost 20% over the past month has confirmed as much.
That yield spike is victimizing two of last year’s top-performing bond ETFs: The PIMCO 25+ Year Zero Coupon US Treasury (NYSEArca: ZROZ) and the Vanguard Extended Duration Treasury ETF (NYSEArca: EDV).
Last year, ZROZ and EDV surged 48.7% and 44.7%, respectively. This year is a different story for the pair. EDV and ZROZ are each off more than 9% and those losses are accelerating with the pair being off an average of 13.8% over the past month. Those losses are attributable to the zero-coupon bonds the ETFs hold.
Zero-coupon bonds often sell at a sizable discounts to face value because buyers do not get a steady stream of income as they do with traditional bonds. As zero-coupon Treasurys get close to maturity, their value increase with buy-and-hold investors getting the full value of the bond when it matures. [The Scoop on two High-Flying Bond ETFs]
Because zero-coupons do not deliver regular income, the bonds and ETFs such as ZROZ and EDV are vulnerable to increase in short-term interest rates. These ETFs are extremely sensitive to interest rate fluctuations due to durations north of 27 years for ZROZ and 24.9 years for EDV. EDV and ZROZ have already shown investors the risks of stripped coupons in rising rate environments. When Treasury yields spiked in 2013, EDV and ZROZ lost an average of 20.5%. [Long Duration ETFs Will Suffer if Rates Rise]
“I’ve heard one pundit on CNBC blame last night’s selling on margin calls. Bonds have been falling since February. We continually monitor TLT and ZROZ,” said Street One Financial Vice President Paul Weisbruch in a note out Wednesday. “They have both broken through their 200D-SMA’s and are about to test November 2014 lows. There appears to be fairly good support at 118.30 for the TLT and at 107.50 for the ZROZ. The bias will remain to the downside while they remain below their 200DSMA’s.”
Since the start of the current quarter, EDV and ZROZ have lost over $23 million on a combined basis.
Vanguard Extended Duration Treasury ETF
