Eric Dutram: Treasury bond ETFs have been having a dream run since mid 2011, primarily thanks to the monetary stimulus program incorporated by the Federal Reserve. The Fed has single handedly emerged as the largest buyer of Treasury Bonds which has resulted in a massive increase in its balance sheet since 2008.
Considering the last couple of years we have had the Operation Twist, followed by the QE3 and now the open ended bond buying program which has replaced these others. To sum it all up, the Fed has been trying its utmost to keep long term borrowing costs low and is at the same time ensuring adequate liquidity in the market.
This had a huge impact on bond ETF investors. Due to the Fed bond buying program coupled with increased demand for Treasury bonds during the equity market turmoil in 2011, it led to a rally in the Treasury bond market. However, it also caused the interest rates to plunge extremely low leaving a pathetic amount of current income.
Yet there is now some speculation that this may be changing soon. The minutes of the last FOMC meeting caused widespread panic among bond investors as most of the Fed members showed concern about continuing the programs indefinitely.
Nevertheless, with a weak GDP report and concerns over spending, Treasury Bonds can experience a flight to safety mode yet again. This could be especially true if the sequester goes into effect or if Europe and other international markets see weakness in 2013 (read Time to Exit Treasury Bond ETFs?).
With this backdrop, investors seeking exposure in the Treasury Bond ETF space can consider the following Zacks top ranked bond ETF as a safe haven instrument to ride out the stock volatility.
About the Zacks ETF Rank
The Zacks ETF Rank provides a recommendation for the ETF in the context of our outlook of the underlying industry, sector, style box, or asset class. Our proprietary methodology also takes into account the risk preferences of investors as well.
The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of five ranks within each risk bucket. Thus, Zacks Rank reflects the expected return of an ETF relative to other ETFs with similar level of risk (see more in the Zacks ETF Center).
Using this strategy, we have found a Ranked 2 or ‘Buy’ Treasury Bond ETF which we have highlighted in greater detail below:
Launched in January of 2007, iShares Barclays Short Treasury Bond ETF (NYSEARCA:SHV) tracks the Barclays Capital U.S. Short Treasury Bond Index which measures the performance of short term U.S. Treasury Bonds with a residual maturity of less than or equal to a year.
The ETF targets the immediate end on the yield curve with a weighted average maturity of 0.43 years. Also, it is subject to negligible interest rate risk primarily due to its short term focus as indicated by a weighted average duration of 0.43 years.
Furthermore, in terms of credit risk the ETF seems to be well placed. This is because the government bonds have virtually no default risk, thanks to their ability to print money to pay off bills.
However, the ETF is not an appropriate choice for aggressive bond investors seeking high returns as the scope for current income and capital appreciation is very limited. Therefore it should primarily be considered for stability and protection (read Target Date Bond ETFs: Best or Worst Fixed Income Funds?).
SHV will be an appropriate and low cost choice for investors seeking to ride out the current short term market volatility and uncertainties over the debt ceiling debate. However, apart from acting as the safe haven investment avenue, the ETF would serve very little purpose.
In terms of popularity and liquidity, the ETF seems to be well placed as it has a huge asset base of around $2.45 billion and does a daily volume of around 287,000 shares. Its low cost structure of just 15 basis points is an added advantage for the ETF.
The iShares Barclays Short Treasury Bond ETF (SHV) typically invests in short term fixed income securities issued by the U.S. Treasury. It invests across 14 securities with around 93% of its total assets invested in the top 10 holdings. All components are U.S. dollar denominated thereby eliminating any currency risk.
Not surprisingly, over the past three years, the ETF price has remained virtually unchanged given its very low levels of interest rate sensitivity and the near zero short term treasury interest rates. Also, the short term focus of SHV does not make it a good candidate for high levels of current income (see Which Volatility Hedged ETF Should You Consider?).
However, the ETF has lived up to its safe haven status and has gone a long way in protecting investors’ capital over the long haul. This makes it an interesting choice for those worried about both a bond bubble and near record stock prices as we push further into 2013.
In 1978, Len Zacks discovered the power of earnings estimates revisions to enable profitable investment decisions. Today, that discovery is still the heart of the Zacks Rank, a peerless stock rating system whose Strong Buy recommendation has an average return of 26% per year.