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These are trying times for the fixed income world, in particular the U.S. Treasury market, as investors are pouring money into the rising equity markets since the start of the year. Plus, market apprehensions relating to the Fed’s possible announcement of scaling back some of its asset purchases in the September FOMC meeting took a toll on the bond markets for a couple of months.
This resulted in soaring yields and a huge sell-off in the global bond markets. Yields on 10-year Treasury notes climbed to 3% in early September from a low of 1.6% in May.
According to Trim Tabs Investment Research, total bond funds shed $20.3 billion in the first part of the half of September, compared to total outflows of $37.4 billion in August, $14.8 billion in July and record $68.6 billion in June (read: Bond ETFs Experience Massive Outflows).
This trend is likely to rebound in the coming weeks as the Fed finally refrained from withdrawing the stimulus, keeping the current bond buying program intact.
No Taper: Life to Treasury Bonds
In the latest FOMC meeting, Ben Bernanke put QE3 tapering on hold until pronounced growth is seen in the economy. Instead, it lowered the GDP growth outlook to 2%–2.3% from 2.3%–2.6% for this year, citing concerns of tight fiscal policy and higher mortgage rates.
Further, the Fed reiterated that the interest rates would stay near zero level and would not be increased until the unemployment rate falls below 6.5% and inflation exceeds their target.
This surprising move cheered the market and breathed life into the depressed bond world. Following the no taper announcement, bond yields fell sharply and Treasury bonds climbed. This was especially true in the yields on 10-year Treasury notes that fell sharply by 10 bps to 2.75% while the 5-year note dropped 12 bps to 1.49% on the day (read: 'No Taper' and the Impact on Broad Market ETFs).
The bull market in bonds seems to have a little bit of life left based on the Fed decision. As such, investors seeking to play on the fixed income space may find it difficult to ignore this opportunity to tap into the space.
How to Play?
We have highlighted three Treasury bond ETFs that could continue to offer price appreciation to investors as long as the Fed does not taper. The trio have a decent Zacks Rank of 3 or ‘Hold’ rating as well, suggesting that these could be a good picks at present (see: all the Government Bonds ETFs here).
iShares 3-7 Year Treasury Bond ETF (IEI)
This ETF targets the intermediate part of the yield curve having maturity of at least 3 years and less than 7 years by tracking the Barclays U.S. 3-7 Year Treasury Bond Index. It is one of the most popular and liquid ETFs in the Treasury space with AUM of over $5.2 billion and average daily volume of nearly 1.1 million shares.
With holdings of 66 securities in its basket, effective duration comes in at 4.42 years while average maturity is 4.64 years. The product charges 15 bps in expense ratio, while the fund lost nearly 1.6% in the year-to-date period and pays 1.32% in 30-day SEC yield.
Schwab Intermediate-Term U.S. Treasury ETF (SCHR)
This fund follows the Barclays U.S. 3-10 Year Treasury Bond Index, holding 59 securities in the basket. It has amassed $302.3 million in its asset base while sees moderate volume of more than 53,000 shares per day.
The product has effective duration of 5.11 years and average maturity of 5.53 years. The ETF is the low cost choice, charging only 10 bps in fees per year from investors (read: Medium Term Treasury Bond ETF Investing 101). In terms of performance, the fund is down 2.4% year-to-date while pays 1.42% in 30-day SEC yield.
iShares U.S. Treasury Bond ETF (GOVT)
This product provides diversified exposure to U.S. Treasuries and tracks the Barclays U.S. Treasury Bond Index. The fund is unpopular with AUM of under $100 million while trades in moderate volume of above 70,000 shares per day. The ETF has expense ratio of 0.15%.
In total, the fund holds 58 securities in the portfolio. About three-fifths of these have a maturity of less than 5 years while 30% have a maturity in between 5–10 years. This gives average maturity of 6.16 years and effective duration of 4.82 years. Further, GOVT yields 1.28% in 30-day SEC and lost around 2.4% in the year-to-date time frame (see more in the Zacks ETF Center).
Treasury bond ETFs were the worst hit by tapering talks this year as the rise in interest rates might cause big losses in these products. However, the surprising move by Ben Bernanke has fueled new hopes into this corner of investing and investors could enjoy a nice bounce back in the coming weeks.
Still, investors should take some caution, as the next round of taper talk is seemingly under way soon, suggesting that these may just be short-term picks, but ones that look to rise if the Fed fails to taper once again.
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