NEW YORK (
) -- Investors seeking income often begin with U.S. government bonds as their first choice, given perceived safety considerations. It's ironic, following recent comments from Moody's, for example, that the U.S. credit rating may be under review for a downgrade in the next month. Given this news and the heavy supply of issuance needed to fund government operations, its odd yields remain near historic lows. The reason for this is a combination of factors: Quantitative easing operations have the
buying bonds, which takes some supply off the market. This QE is scheduled to end this month.
Further, economic data has been weak, leaving authorities with little choice but to keep interest rates low. Demographics result in an aging population in the west seeking income over growth. Tied to this has been an outflow of funds from equities to bonds, given both demographics and a lack of trust in equities.
We look at 10 different bond ETF sectors, including those that are repetitive, varying only slightly by holdings and perhaps more so by varying embedded fees and expenses. While we'll look at just 10 issues overall, we'll mention the competitive issue and variance in fee structure.
Large institutions (insurance companies and pension plans) and even smaller asset allocation models either include government bonds as components in portfolio structure, with some being mandated to do so. Large institutions use bonds to meet various actuarial table requirements to meet retirement schedules and life insurance tables. Financial planners and advisers use bonds traditionally as a portfolio risk-management tool, given their historical noncorrelation to equity sectors.
We'll also view popular so-called inflation-protected issues, but with some reluctance and caution. These issues, no matter the maturity/duration features, are primarily linked to the same inflation measurement -- the relative Consumer Price Index.
Personally, I find this linkage to be unfair to the borrower versus the issuer, given the flawed nature of the index. It's my opinion, and that of others, that these measures understate true inflation. (
Shadow Stats does an excellent job of detailing a better view of inflation data.)
Another factor for taxable investors to consider is that they must pay ordinary income taxes on the so-called "imputed rate" of interest earned but not paid on the inflation component. Lastly, many institutional investors are required to own these securities by the terms of their mandate and other considerations whereas individual investors need not be so restricted.
Let's look at typical choices.
iShares Barclays 1-3 Year Treasury Bond ETF
has the highest amount of assets under management, $8.2 billion, and an average daily trading volume just under 1 million shares. The expense ratio is .15% and it's been in existence since July 2002.
The yield is .98% and 1-year return as of May 2011 is 1.70%. With yields this low, you might consider this ETF and its competitors similar to cash on the sidelines or safe-parking. Competitive issues include Vanguard's
, begun in November 2009 with similar holdings and an expense ratio of .15%, AUM of $121 million, daily trading volume 18K shares and similar returns and yield; Schwab's
tracking the same index but with a slightly lower expense ratio of .12% and AUM of $110 million; PIMCO's
tracking BofA Merrill Lynch 1-3 Year Treasury Index with an expense ratio of .09% begun in June 2009 with AUM of $107 million.
Data as of May 2011
SHY Top Ten Holdings & Weightings
- US Treasury Note 1.25%: 14.36%
US Treasury Note 0.75%: 9.00%
US Treasury Note 1.75%: 7.51%
US Treasury Note 1.375%: 6.70%
US Treasury Note 0.75%: 5.56%
US Treasury Note 1%: 5.23%
US Treasury Note 1.125%: 5.06%
US Treasury Note 1.75%: 3.59%
US Treasury Note 1.375%: 3.13%
US Treasury Note 1.375%: 2.65%
iShares Barclays Capital U.S. 7-10 Year Treasury Bond Index ETF
is another early listing by Barclays and therefore has captured the most AUM at $3.3 billion, daily trading volume of just less than 1 million shares per day, an expense ratio of .15%, a 1-year return as of June 2011 of 7.41% and a yield of 3.11%. This is an important sector, since it's from this area where mortgage rates are generally priced.
Competitive issues also abound, starting with Vanguard's
, tracking the same Barclays index, but begun in November 2009. It has an expense ratio of .15%, AUM of $40 million, average daily trading volume at only 7,700 shares; SPDR's
(SPDR Barclays Intermediate Term Treasury ETF) launched in May 2007 and only offers a marginal difference between IEF and VGIT in components, but has a lower expense ratio of .13%, AUM of $214 million and average daily trading volume of 20,000 shares; Schwab's
(Barclays Capital 3-10 year ETF), with a shorter duration, features less volatility but overall about the same results. AUM is $50 million, average daily trading volume 18,000, and it has a low expense ratio of .12%.
Data as of May 2011
IEF Top Ten Holdings & Weightings
- US Treasury Note 3.625%: 13.14%
US Treasury Note 3.75%: 10.92%
US Treasury Note 3.5%: 9.88%
US Treasury Note 3.375%: 9.68%
US Treasury Note 3.625%: 8.43%
US Treasury Note 3.125%: 8.03%
US Treasury Note 2.75%: 7.88%
US Treasury Note 3.625%: 7.08%
US Treasury Note 2.625%: 6.43%
US Treasury Note 2.625%: 5.78%
iShares Barclays 20 Year Plus Treasury ETF
is one of the most popular trading issues available, and like
, also has leveraged and inverse issues available for traders from ProShares and similar issues from Direxion. Begun in July 2002, it has been the most watched and traded fixed income ETF.
AUM exceeds $3.2 billion, average daily trading volume is more than 8 million shares, the current yield is 4.25% and the 1-year return through June 2011 is 6.21%. The expense ratio is .15%.
Competitors include Vanguard's
(Barclays Capital U.S. Long Government Bond ETF) launched in November 2009 and the index includes fixed-income securities and U.S. Treasury, U.S. government agencies as well as corporate debt guaranteed by the U.S. government and has maturities beyond 10 years. The expense ratio is .15%, AUM equal $27 million, average daily trading volume is a low 10,000 shares, current yield is 3.64% and the 1-year return is 6.60%.
Data as of May 2011
TLT Top Ten Holdings & Weightings
- US Treasury Bond 4.625%: 10.52%
US Treasury Bond 4.375%: 10.17%
US Treasury Bond 4.375%: 10.02%
US Treasury Bond 4.25%: 9.96%
US Treasury Bond 3.875%: 9.39%
US Treasury Bond 4.5%: 8.59%
US Treasury Bond 4.75%: 7.75%
US Treasury Bond 4.25%: 7.32%
US Treasury Bond 4.5%: 5.83%
US Treasury Bond 3.5%: 5.03%
iShares Barclays 3-7 Year Treasury ETF
tracks the Barclays Capital U.S. 3-7 Year Treasury Bond Index and was launched May 2007. Generally speaking, this sector, given rollover of assets and reinvestment, would follow 5-year Treasury auctions.
AUM is $1.5 billion with average daily trading volume of 133,000 shares, the current yield is around 2%, the 1-year rate of return has been 5.53% and the expense ratio is .15%.
A competitive issue is from PIMCO's
(BoA Merrill Lynch 3-7 Year U.S. Treasury ETF) which was issued October 2010 and has the same expense ratio of .15%, the current yield is 2%, AUM equals $20 million and average daily trading volume is under 4,000 shares. The 1-year return has been 4.95%.
Data as of May 2011
IEI Top Ten Holdings & Weightings
- US Treasury Note 1.75%: 6.61%
US Treasury Note 2.75%: 6.48%
US Treasury Note 3.125%: 6.36%
US Treasury Note 2.625%: 5.61%
US Treasury Note 3.25%: 5.57%
US Treasury Note 3.125%: 5.52%
US Treasury Note 2.75%: 4.37%
US Treasury Note 4.25%: 3.79%
US Treasury Note 2.625%: 3.72%
US Treasury Note 2.625%: 3.55%
iShares Barclays Capital U.S. Agency Bond ETF
just follows U.S. agency bonds. It was launched in November 2008. It has AUM of $376 million, trades a daily average of 26,000 shares, an expense ratio of .20% , a current yield of 1.84%, a 1-year total return through May 2011 of 3.43% and all agencies still carry AAA ratings. No question things were rocky in 2008.
Data as of May 2011
AGZ Top Ten Holdings & Weightings
- Bank Of America Gtd 3.125%: 7.34%
FHLBA 3.625%: 5.82%
FHLMC 4.5%: 5.03%
FHLBA 4%: 5.02%
FHLMC 1.75%: 4.13%
FHLMC 1.15%: 3.50%
FHLMC 4.375%: 3.45%
FNMA 1.125%: 3.26%
FNMA 4.375%: 2.82%
FNMA 2%: 2.41%
There are plenty of other government bonds but most are repetitive to these issues and/or have low AUM and little liquidity for now. We move on to inflation protected government bonds which include on overseas issue.
iShares Barclays Capital U.S. Treasury Inflation Protected Bond ETFs
the index includes all publicly issued, U.S. Treasury inflation-protected securities that have at least one year remaining to maturity, are rated investment grade, and have $250 million or more of outstanding face value. This popular issue was first issued in December 2004.
As previously stated, I have misgivings about the strategy of achieving inflation protection using these securities. That said, many institutions use them since their pension fund clients, for example, believe it a prudent strategy despite its many short-comings.
The expense ratio is .20% and AUM is now $20 billion, with average daily trading volume around 800,000 shares. The average duration of the holdings is less than 10 years. The current yield is 2.75% and 1-year total return as of May 2011 is 7.80%.
Data as of May 2011
TIP Top Ten Holdings & Weightings
- US Treasury Bond 2.375%: 5.05%
US Treasury Bond 3.875%: 4.90%
US Treasury Note 1.375%: 4.53%
US Treasury Note 1.875%: 4.37%
US Treasury Note 2%: 4.29%
US Treasury Bond 3.625%: 4.17%
US Treasury Note 3%: 4.03%
US Treasury Note 2%: 3.87%
US Treasury Note 1.125%: 3.84%
US Treasury Note 1.625%: 3.73%
DB Global Government ex-US Inflation-Linked Bond Capped ETF
has a description that might take some time get out of your mouth. The bottom line, like TIP, it gives you exposure to both developed and emerging market bonds from outside the U.S. The ETF was launched by State Street in March 2003. It has a relatively high expense ratio of .50%, AUM of $1.35B and average daily trading volume of 163K shares.
The current yield as of May 2011 is a little more than 2% and 1-year performance is a whopping 17.28%. Much of this success is due to more realistic inflation measurements away from the U.S. and we must remember inflation data in emerging markets is high, allowing for better adjustments.
Data as of May 2011
WIP Top Ten Holdings & Weightings
- United Kingdom 1.44962%: 6.92%
Government of France 2.56835%: 5.23%
Government of Japan 1.0857%: 4.63%
Government of France 1.07943%: 4.19%
United Kingdom 2.05188%: 3.65%
Republic of Turkey 9.86678%: 3.17%
Government of France 1.78968%: 3.05%
Federal Republic of Germany 1.64%: 3.04%
United Mexican States 5%: 2.82%
Republic of Italy 2.79903%: 2.78%
PIMCO BofA Merrill Lynch 1-5 Year U.S. Inflation-linked Treasury ETF
was issued in August 2009. It's an unmanaged index that consists of U.S. issues with at least $1 billion in face value and duration as stated. AUM is already at $1.15 billion, the expense ratio is .20%, average daily trading volume is 160,000 shares, a current yield of roughly 1.73% and a 1-year return as of May 2011 of 5.49%.
Data as of May 2011
STPZ Top Ten Holdings & Weightings
- US Treasury Note 3%: 12.02%
US Treasury Note 2%: 10.86%
US Treasury Note 1.875%: 10.33%
US Treasury Note 2%: 9.70%
US Treasury Note 1.625%: 9.46%
US Treasury Note 0.5%: 8.92%
US Treasury Note 1.875%: 8.43%
US Treasury Note 2%: 8.29%
US Treasury Note 2%: 7.80%
US Treasury Note 1.25%: 6.76%
Barclays Capital U.S. Government Inflation-linked Bond ETF
is a State Street issue launched in May 2007 featuring Treasury inflation-linked bonds with maturities in excess of 1 year extending to over 20 years with an issue size in excess of $500 million. AUM is now $436 million, average daily trading volume is around 60,000 shares, the expense ratio is .18%.
Data as of May 2011
IPE Top Ten Holdings & Weightings
- US Treasury Bond 2.375%: 5.45%
US Treasury Bond 3.875%: 5.24%
US Treasury Note 1.25%: 5.00%
US Treasury Bond 3.625%: 4.42%
US Treasury Note 3%: 4.41%
US Treasury Note 2%: 3.99%
US Treasury Note 1.875%: 3.82%
US Treasury Note 1.125%: 3.76%
US Treasury Note 2.5%: 3.69%
US Treasury Note 2%: 3.57%
iShares Barclays Capital Treasury Inflation-Protected 0-5 Year ETF
was issued by iShares in March 2010 to fill the gap for a short-term TIP product. In the short period since issuance, AUM already exceeds $150 million and average daily trading volume is around $26,000. The expense ratio is rather high at .20%, given the shorter duration. The current yield has been changing, given capital gains and reinvestment conditions. Through May 2011, the 1-year return has exceeded 4%.
Data as of May 4, 2011
STIP Top Ten Holdings
- US Treasury Note 3%: 10.10%
US Treasury Note 2%: 9.99%
US Treasury Note 1.875%: 9.66%
US Treasury Note 2%: 9.07%
US Treasury Note 1.625%: 8.70%
US Treasury Note 0.5%: 8.45%
US Treasury Note 1.875%: 7.93%
US Treasury Note 2%: 7.75%
US Treasury Note 1.25%: 6.37%
US Treasury Note 2%: 6.05%
Once again we've chosen to keep the list to 10, although other competitors are mentioned frequently. All of this is a matter of choice for any investor. These lists remain long and sometimes quite repetitive as components vary little one to another. The real choice here is maturity selection or what duration risk are you willing to assume. The longer out the curve you go, the greater the return and risk to principal.
As a former bond principal, I'm really not in favor of bonds now. It may be I suffer from the "the closer you are to something, the less you like it" syndrome. Nevertheless, yields are skimpy and risks from budding inflation high with longer maturities. With shorter maturities, you do little better than yields from the bank after headline inflation. So, given the environment with many uncertainties, "cash" from money market funds and/or T-Bills is just fine for now.
I'm not particularly impressed with the inflation calculations for most U.S. bond issues, believing there's very little real protection when the inflation component is flawed. That said, we are long some of these issues because as trend-followers, that's what we do.
Remember, many institutions (insurance companies, pension plans and many asset allocation models) call for large bond allocations. Some insurance companies may only own bonds, given their actuarial table requirements. If you're an individual investor, you're not under the same pressures, no matter what you hear in the media.
Further, previous non-correlations of bonds to stocks, for example, have been whittled away, given current monetary policies of the Fed. This only adds to risks already mentioned.
If you must buy them, our bias generally is to more liquid issues unless we utilize them in Lazy portfolio approaches. Just always remember, ETF sponsors must issue and many times their interests aren't aligned with yours. They have a business interest and wish to have a competitive presence in any popular sector.
For further information about portfolio structures using retail or other ETFs see
You may address any feedback to: firstname.lastname@example.org
(Source for holding data is from ETF Database.)
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This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.
At the time of publication, Fry was long SHY, IEF, TIP
Dave Fry is founder and publisher of
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