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Investors Pour Money Into Long-Bond ETFs

As the financial crisis stretches on, longer-dated debt and municipals benefit from a flight to safety.
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There is no shortage of disappointing news during this festive season, and this is reflected in our top-rated ETFs for November. We have seen a flight to quality, driven by risk aversion, into such securities as U.S. Treasuries and, to a lesser extent, municipals.

The most highly rated ETFs were dominated by foreign funds as recently as early 2008 and leveraged short funds just a few months ago. That has completely changed. The uncertainty of the depth of this downturn gives little transparency for 2009 company earnings. This, in turn, has affected the perception of risk in the marketplace, leading to one of the most powerful of emotions, fear, dictating investment decisions.

There may be undervalued stocks out there, but all bets are off until some form of order is restored to the financial system. Despite massive government spending, there need to be signs that unemployment is stabilizing. We now have a vicious cycle that is feeding on itself and likely to get worse with further "shoes to drop" in the new year, such as increased defaults in construction loans and credit cards, the possibility that falling commodity prices will trigger collapses in the farming sector, taking rural banks with them, and the ever-present danger for the stock market of hedge-fund repatriations, especially in the light of the alleged Madoff fraud.

This month's list shows that the flight to U.S. government securities has been across maturities, ranging from three- to seven-year issues via the

iShares Lehman 3-7 Year Treasury Bond Fund


to 10- to 20-year bonds via the

iShares Lehman 10-20 Year Treasury Bond Fund


. Note that the shorter-term securities have already experienced considerable price appreciation this year and, hence, investors have started to bid up the prices of longer-dated securities, leading to the 11.89% return for TLH in November, as opposed to the 3.68% return for shorter-dated issues. This has resulted in a flattening of the yield curve.

Other observations from the list include the presence of investment-grade corporate bonds, some of which are virtually guaranteed via the plethora of government-bailout plans. As I stated in my previous


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, if the federal government is going to support the corporate-credit market, it has to be ready to support the municipal market. This gives risk-averse investors a reason to consider municipals.

The PowerShares DB US Dollar Bullish Fund


is an interesting inclusion on the list, but that's as far it goes because the direction of the U.S. dollar is unknown, especially in light of possible interest-rate cuts and the amount of funding from new Treasury issues the Obama government looks set to make. This may lead to a weakening of the U.S. dollar.

At the bottom of the list is the

ProShares Short Small Cap 600


, which still may offer an opportunity into 2009. The stock-market downdraft is by no means over.

Sam Patel, CFA, is the manager of mutual fund research for the Ratings.

In keeping with TSC's Investment Policy, employees of Ratings with access to pre-publication ratings data must pre-clear any potential trade through the legal department, and are prohibited from trading any security that is the subject of an unpublished rating revision until the second business day after the rating is published.

While Patel cannot provide investment advice or recommendations, he appreciates your feedback;

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