Treasury ETFs

Photo by: Ryan McFarland

U.S. Treasuries surged in popularity during the recent crisis.  In fact at one point people were so anxious to buy up treasuries that the short-term yield dropped to 0%.  At this point Warren Buffet emailed his directors:

This should be bullish for Berkshire. With great foresight, I long ago entered the mattress business in a big way through our furniture operation. Now mattresses have become fully competitive as a place to put your money, and sales will soon take off.1 

People were anxious to find a safe place to put their money, which is one of the strong suits of U.S. Treasuries. 

Treasuries have a very different risk profile than many other investments.  There is a very low risk of default compared to other types of bonds, but you are exposed to risks like inflation.  ETFs can provide a way to introduce this risk profile into our portfolios more easily than actually buying the bonds.  There are several ETFs which allow you to do this and many concepts that can be pivotal to understand before doing so.  

Understanding Yields and Prices

Bond prices and yields can be a bit opaque to those without experience; however they are a fairly simple concept.  When a bond is issued, it pays a certain amount and has a certain cost.  Say for example I buy a $10,000 bond that will pay me $300 per year.  Thus it yields 3%.  Now many would think that since the bond will repay my $10,000 at the end of its life, it would be a risk-free investment.  However suppose that interest rates go down at that 3% becomes more attractive, people will be willing to pay more for that same bond.  As the price goes up, the $300 per year becomes a smaller fraction and the yield of the bond goes down.  Meanwhile if interest rates go up, my bond becomes less attractive and the price will go down.  

This is very important when considering inflation.  Generally if inflation is high, you will see higher interest rates.  As such in an inflationary environment, bond yields tend to increase, meaning the price of any bonds you own may very well go down.  This means that the term of the bond becomes very important.  While over a short period of time, inflation may be predictable; over long periods any number of things can happen to affect interest rates.  Obviously because of this, longer dated bonds tend to pay higher yields.  

Treasury ETFs

There are many treasury ETFs and will likely be many more in the future.  Some of the more popular ones include:

TLT – Long Term Treasuries

This fund “seeks to approximate the total rate of return of the long-term sector of the United States Treasury market as defined by the Barclays Capital US 20+ Year Treasury Bond Index.”2 Thus if you want to buy long-term treasuries, this could be a good fund for you.  When buying a fund like this it is important to consider how inflation may affect yields over a long period of time.  These bond funds are committing money for long periods of time, so if we have inflation or high interest rates, these funds can lose considerable value.  Also, because of their long period they can be much more volatile than shorter dated bonds.

Currently the market has been reflecting fears about inflation as TLT prices have been dropping and yields improving.  This suggests that the market thinks inflation is a serious concern at that these bonds need to be lower priced to be competitive.  This may be a result of increased optimism about an impending recovery in the US.  

SHY – Short Term Treasuries

This fund “seeks to approximate the total rate of return that correspond generally to the price and yield performance, before fees and expenses, of the short-term sector of the United States Treasury market as defined by the Barclays Capital 1-3 Year US Treasury Index.”3 Because of its short term, this ETF is not very volatile at all.  For example, during the 52 weeks from the time of this writing its range has been 82.07 – 85.17.4  One would not expect to see a tremendous price change in such short term notes, which can be either a good thing or a bad thing depending on your objectives. 

IEF – Intermediate Term Treasuries

This fund “seeks to approximate the total rate of return of the intermediate-term sector of the United States Treasury market as defined by the Barclays Capital 7-10 Year US Treasury Index.”5 Thus this fund runs the middle ground between the other two.  It tends to be more volatile than the SHY, but less than the TLT. 

TIP – Treasury Inflation Protected Securities

Another popular type of treasury is Treasury Inflation Protected Securities.  These bonds have their principal adjusted annually to reflect changes in the Consumer Price Index.  The TIP “seeks results that correspond generally to the price and yield performance, before fees and expenses, of the inflation-protected sector of the United States Treasury market as defined by the Barclays Capital U.S. Treasury Inflation Protected Securities (TIPS) Index (Series-L).”6 This provides an interesting middle ground where your investment is not as exposed to the risk of inflation.  At the same time these bonds have a differing tax-treatment and are likely to pay lower base yield. 

Other ETFs

In addition to other ETFs that seek to emulate the exact same returns, there are also leveraged ETFs which seeks to return some multiple of the movement of these funds.  One example would be TBT which seeks to return double the inverse of the TLT.  Thus if the TLT goes up 10% in a day the TBT would go down 20%.  There are a wide variety of ways to invest in treasuries.  These funds can provide additional options to your investment playbook, but should be thoroughly researched before used.  

[Disclosure:  I am currently long TLT with offsetting call options sold to hedge my position]

1. Forbes – Buffet Bets On Mattresses [↩]
2. iShares TLT Product Information [↩]
3. iShares SHY Product Information [↩]
4. Yahoo! Finance – Shy [↩]
5. iShares IEF Product Information [↩]
6. iShares TIP Product Information [↩]

One Response to “Treasury ETFs”

1. Giorgio says:

   June 12, 2009 at 1:42 pm

   I Brad,

   I read your website via David’s blog.

   Congratulations for your last interesting post which shows the importance of the term of the bond in an inflationary environment.

   Best Regards
   Giorgio