Ben Bernanke’s testimony before Congress finally seems to have provided some much needed clarity to the market. The speculation over the outcome of the Federal Reserve bond buying program seemed to be the biggest worry for the markets.
And finally it seems that the possibility of a premature end to the monetary stimulus, which was earlier hinted at, has been scrapped by the outcome of this testimony. Therefore the Federal Reserve seems likely to continue with the purchase of mortgage backed securities and treasury bonds worth $85 billion until the unemployment and inflation thresholds are met (read Have We Seen the Bottom in Gold ETFs?).
Nevertheless, the loose monetary policy being implemented by the Fed since 2008 has resulted in very low, or even negative, real interest rates in the economy.
Thus, yield hungry investors have had to look into a variety of sources in search of current income. Some conservative investors have even had to wander beyond their comfort zone to riskier avenues such as junk bonds and dividend paying equities in search of yields.
Yet with Bernanke providing clarity on the bond buying program, rates are expected to remain lower for some more time. This is especially true taking into account the fact that the Federal Reserve is the single largest purchaser of Treasury Bonds.
Of course, this has had a tremendous impact on the Federal Reserve’s balance sheet which has expanded to gigantic proportions (read Can the Dollar ETF (UUP) Finally Break Out?).
Treasury Bond ETFs, especially the longer dated ones, had a terrific run in the recent past following a series of global economic crises since 2009. This was followed by ‘a few’ quantitative easing programs by the Federal Reserve, as well as ‘Operation Twist’ which was aimed at keeping long term interest rates low.
All these factors surely did push treasury yields lower and bond prices higher. However, things are not quite the same at this moment. The 10 year treasury rates back then in the latter part of 2009, were well above 3.5%. Therefore one could argue there was substantial room for depressing interest rates at the time.
However, with the benchmark 10 year rates nearing 1.88% at present, the biggest question still remains—How low can yields go from current levels despite continuation of the monetary easing measures? Probably not too much further, thus one could make a case for limited profit potential of the Treasury Bond ETFs in the future.
Despite all these arguments, the inevitable cannot be changed—The Fed has to suck back liquidity from the economy and interest rates will rise causing bond prices to fall sometime in future. But that ‘sometime’ seems to be quite far off from now.
Nevertheless, let us have a look at some of the choices from the Treasury Bond ETF space. These could be good avenues to park money, given the possibility of the sequester which may cause risk aversion once again and a switch from equities into bonds (read With Sequester Ahead, Are Defense ETFs in Trouble?).
iShares Barclays 20+ Year Treasury Bond ETF (TLT - ETF report)
The ETF tracks the longer end of the yield curve with a weighted average maturity of 27.51 years. Being a long term treasury bond ETF it carries a high interest rate risk as measured by the effective duration of 16.87 years.
TLT was launched in July of 2002 and since then has managed to amass an asset base of $3.11 billion. It charges investors 15 basis points in fees and expenses. It has a concentrated portfolio of just 20 securities in its portfolio with around 74% of its total assets invested in the top 10 holdings.
TLT has a distribution yield of 2.64% and has returned 3.25% in the fiscal year 2012. It has a Zacks ETF Rank of 3 or ‘Hold’.
Vanguard Long Term Government Bond ETF (VGLT - ETF report)
The ETF follows the Barclays Capital U.S. Long Government Float Adjusted Bond Index. The index measures the performance of U.S Treasury securities having a residual maturity of more than 10 years.
VGLT has a portfolio of 63 securities in all with a yield to maturity of 2.90%. The ETF has a weighted average maturity of 23.8 years and an average duration of 16.1 years. The ETF has an asset base of $236.77 million and charges investors 12 basis points in expenses (see Time to bank on Regional Bank ETFs?).
VGLT has returned 3.25% in the last one year period as of 31st December 2012. It also has a Zacks ETF Rank of 3 or ‘Hold.’
iShares Barclays 10-20 Year Treasury Bond ETF (TLH - ETF report)
The ETF tracks the performance of Treasury Bonds having a residual maturity between 10 to 20 years. It tracks the Barclays Capital U.S. 10-20 Year Treasury Bond Index. The ETF was launched in January of 2007 and since then has been able to amass an asset base of $454.69 million.
Like its iShares counterpart TLT, the ETF also has a fairly concentrated portfolio of 20 securities in all with 71% of its total assets invested in the top 10 holdings. The ETF has a weighted average maturity of 13.97 years and an effective duration of 9.96 years.
The product has returned 4.09% for the fiscal year 2012 and has a distribution yield of 2.02%. TLH has an expense ratio of 0.15%. The ETF has a Zacks ETF Rank of 3 or ‘Hold’.
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