Investors seeking income often begin with U.S. government bonds as their first choice given perceived safety considerations. It's ironic given 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. QE (Quantitative Easing) operations have the Fed buying bond 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 Advisors 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 CPI (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, 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 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.

SHY (iShares Barclays 1-3 Year Treasury Bond ETF) follows the Barclays Captal U.S. 1-3 Year Treasury Bond Index. The fund was launched in July 2002. The expense ratio is .15%. AUM (Assets under Management) equal $8.2 billion and an average daily trading volume just under 1M shares. As of mid-September 2011 the annual dividend was $.07 making the current yield  .98% and YTD return .80%. 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 VGSH begun in November 2009 with similar holdings and an expense ratio .15%, AUM of $153M, daily trading volume 18K shares and similar returns and yield; Schwab's SCHO tracking the same index but with a slightly lower expense ratio of .12% and AUM of $166M and commission free trading at Schwab; PIMCO's TUZ tracking BofA Merrill Lynch 1-3 Year Treasury Index with an expense ratio of .09% begun in June 2009 with AUM of $112M.

Data as of September 2011

SHY Top Ten Holdings & Weightings
  1. US Treasury Note 1.25%:       14.36%
  2. US Treasury Note 0.75%:       9.00%
  3. US Treasury Note 1.75%:       7.51%
  4. US Treasury Note 1.375%:     6.70%
  5. US Treasury Note 0.75%:       5.56%
  6. US Treasury Note 1%:            5.23%
  7. US Treasury Note 1.125%:     5.06%
  8. US Treasury Note 1.75%:       3.59%
  9. US Treasury Note 1.375%:     3.13%
  10. US Treasury Note 1.375%:     2.65%

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IEF (iShares Barclays Capital U.S. 7-10 Year Treasury Bond Index ETF) follows the index bearing the same name. The fund was launched in July 2002. The expense ratio is .15%. AUM equals $3.3B and daily trading volume is less than 1M shares per day. As of mid-September 2011the annual dividend was $.25 making the current yield .92% and YTD return 10.63%. This is an important sector since it's from this area where mortgage rates are generally priced. Competitive issues abound starting with Vanguard's VGIT, and follows the Barcalys Capital U.S. 3-10 Year Government Index. The fund was launched November 2009. The expense ratio is .15%.  AUM of $62M and average daily trading volume 12K shares; SPDR's ITE (SPDR Barclays Intermediate Term Treasury ETF) follows the index of the same name. The fund was launched in May 2007. The expense ratio is lower at .13%, AUM $220M and average daily trading volume of 20K shares; Schwab's SCHR (Barclays Capital 3-10 year Treasury ETF) follows the index of the same name. The fund was launched August 2010. The expense ratio is is lowest at .12% and features commission free trading for Schwab customers. AUM is $90M and average daily trading volume is 32K shares.

ProShares and Direxion Shares have leveraged long and inverse products available for hedging or speculating.

 

 

 

Data as of May 2011

IEF Top Ten Holdings & Weightings
  1. US Treasury Note 3.625%:     13.14%
  2. US Treasury Note 3.75%:       10.92%
  3. US Treasury Note 3.5%:         9.88%
  4. US Treasury Note 3.375%:     9.68%
  5. US Treasury Note 3.625%:     8.43%
  6. US Treasury Note 3.125%:     8.03%
  7. US Treasury Note 2.75%:       7.88%
  8. US Treasury Note 3.625%:     7.08%
  9. US Treasury Note 2.625%:     6.43%
  10. US Treasury Note 2.625%:     5.78%

TLT (iShares Barclays 20 Year Plus Treasury ETF) follows the index of the same name. The fund was launched in July 2002. The expense ratio is .15%. AUM exceeds $2.8B and average daily trading volume is 13M shares. As of mid-September 2011 the annual dividend was $.32 making the current yield 1.22% and YTD return 18.40%. Alternate choices include Vanguard's VGLT (Barclays Capital U.S. Long Government Bond ETF) follows the index of the same name. The index includes fixed income securities of the U.S. Treasury and U.S. government agencies. The fund was launched in November 2009. The expense ratio is .15%.  AUM equal $43M and average daily trading volume is 15K shares. As of mid-September 2011 the annual dividend was $.19 making the current yield is 1.34% and YTD return 17.85%.

ProShares and Direxion Shares have leveraged long and inverse products available for hedging or speculating.

Data as of September 2011

TLT Top Ten Holdings & Weightings
  1. US Treasury Bond 4.625%:    10.52%
  2. US Treasury Bond 4.375%:    10.17%
  3. US Treasury Bond 4.375%:    10.02%
  4. US Treasury Bond 4.25%:      9.96%
  5. US Treasury Bond 3.875%:    9.39%
  6. US Treasury Bond 4.5%:        8.59%
  7. US Treasury Bond 4.75%:      7.75%
  8. US Treasury Bond 4.25%:      7.32%
  9. US Treasury Bond 4.5%:        5.83%
  10. US Treasury Bond 3.5%:        5.03%

 

 

 

 

IEI (iShares Barclays 3-7 Year Treasury ETF) follows the Barclays Capital U.S. 3-7 Year Treasury Bond Index. The fund was launched January 2007. The expense ratio is .15%. Generally speaking this sector given rollover of assets and reinvestment would follow 5-year Treasury auctions. AUM is $2.1B with average daily trading volume of 246K shares. As of mid-September 2011 the annual dividend was $.19 making the current yield .77%. A competitive issue is from PIMCO's FIVZ  (BoA Merrill Lynch 3-7 Year U.S. Treasury ETF) follows the index of the same name. The fund was launched in October 2009. The expense ratio is .15%. AUM is $21M and average daily trading volume is less than 3K shares.  For the same period the annual dividend was $.09 making the current yield .99% and YTD return 6.35%.

 

Data as of May 2011

IEI Top Ten Holdings & Weightings
  1. US Treasury Note 1.75%:       6.61%
  2. US Treasury Note 2.75%:       6.48%
  3. US Treasury Note 3.125%:     6.36%
  4. US Treasury Note 2.625%:     5.61%
  5. US Treasury Note 3.25%:       5.57%
  6. US Treasury Note 3.125%:     5.52%
  7. US Treasury Note 2.75%:       4.37%
  8. US Treasury Note 4.25%:       3.79%
  9. US Treasury Note 2.625%:     3.72%
  10. US Treasury Note 2.625%:     3.55%

AGZ (iShares Barclays Capital U.S. Agency Bond ETF) follows the Barclays Capital U.S. Agency Bond Index. The fund was launched in November 2008. The expense ratio is .20%. AUM of $360M and average daily trading volume is less than 20K shares. As of mid-September 2011 the annual dividend was $.16 making the current yield .72% and YTD return 2.77%.

 

Data as of May 2011

AGZ Top Ten Holdings & Weightings
  1. Bank Of America Gtd 3.125%:            7.34%
  2. FHLBA 3.625%:                                  5.82%
  3. FHLMC 4.5%:                         5.03%
  4. FHLBA 4%:                                         5.02%
  5. FHLMC 1.75%:                                   4.13%
  6. FHLMC 1.15%:                                   3.50%
  7. FHLMC 4.375%:                                 3.45%
  8. FNMA 1.125%:                                    3.26%
  9. FNMA 4.375%:                                    2.82%
  10. FNMA 2%:                                           2.41%

TIP (iShares Barclays Capital U.S. Treasury Inflation Protected Bond ETFs) follows the index of the same name. The index includes all 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. The fund was launched in December 2004. Individuals must recognize they must pay tax on imputed accretion. Further some could very well question the validity of current methodology of inflation calculations. The expense ratio is .20%. AUM is now $20B with average daily trading volume over 1M shares. As of mid-September 2011 the annual dividend was $.26 making the current yield .72% and YTD return 7.11%.

Data as of September 2011

TIP Top Ten Holdings & Weightings
  1. US Treasury Bond 2.375%:    5.05%
  2. US Treasury Bond 3.875%:    4.90%
  3. US Treasury Note 1.375%:     4.53%
  4. US Treasury Note 1.875%:     4.37%
  5. US Treasury Note 2%:            4.29%
  6. US Treasury Bond 3.625%:    4.17%
  7. US Treasury Note 3%:            4.03%
  8. US Treasury Note 2%:            3.87%
  9. US Treasury Note 1.125%:     3.84%
  10. US Treasury Note 1.625%:     3.73%

 

WIP (SPDR DB Global Government ex-US Inflation-Protected ETF) follows the DB Global Government ex-U.S. Inflation-Linked Bond Capped Index. Inflation protection exposure is to both developed and emerging market bonds. The ETF was launched in March 2008. It has a relatively high expense ratio of .50%. AUM equal of $1.35B and average daily trading volume is 180K shares. As of mid-September 2011 the annual dividend was $.99 making the current yield 1.67% and YTD 2.12%.

Data as of September 2011

WIP Top Ten Holdings & Weightings
  1. United Kingdom 1.44962%:                            6.92%
  2. Government of France 2.56835%:                  5.23%
  3. Government of Japan 1.0857%:                     4.63%
  4. Government of France 1.07943%:                  4.19%
  5. United Kingdom  2.05188%:                           3.65%
  6. Republic of Turkey 9.86678%:                        3.17%
  7. Government of France 1.78968%:                  3.05%
  8. Federal Republic of Germany 1.64%:             3.04%
  9. United Mexican States 5%:                             2.82%
  10. Republic of Italy 2.79903%:                            2.78%

 

 

 

 

STPZ (PIMCO 1-5 Year U.S. Inflation-linked Treasury ETF) follows the BofA Merrill Lynch Inflation Linked Treasury Index. It's an unmanaged index consisting of U.S. issues with at least $1B in face value and duration as stated. The expense ratio is .20%. The fund was launched in August 2009. AUM equal $1.25B and average daily trading volume is 130K shares. As of mid-September 2011 the annual dividend was $.07 making the current yield .37% and YTD return of 1.97%.

Data as of September 2011

STPZ Top Ten Holdings & Weightings
  1. US Treasury Note 3%:            12.02%
  2. US Treasury Note 2%:            10.86%
  3. US Treasury Note 1.875%:     10.33%
  4. US Treasury Note 2%:            9.70%
  5. US Treasury Note 1.625%:     9.46%
  6. US Treasury Note 0.5%:         8.92%
  7. US Treasury Note 1.875%:     8.43%
  8. US Treasury Note 2%:            8.29%
  9. US Treasury Note 2%:            7.80%
  10. US Treasury Note 1.25%:       6.76%

IPE (SPDR Barclays TIPS ETF) follows the Barclays Capital U.S. Government Inflation-linked Bond Index featuring Treasury inflation-linked bonds with maturities in excess of 1 year extending to over 20 years with an issue size in excess of $500M. The fund was launched in May 2007. The expense ratio is .18%. AUM equal now $500M and average daily trading volume is 66K shares. As of mid-September 2011 the annual dividend was $.07 making the current yield .76% and YTD return 7.66%.   

Data as of September 2011

IPE Top Ten Holdings & Weightings
  1. US Treasury Bond 2.375%: 5.45%
  2. US Treasury Bond 3.875%: 5.24%
  3. US Treasury Note 1.25%: 5.00%
  4. US Treasury Bond 3.625%: 4.42%
  5. US Treasury Note 3%: 4.41%
  6. US Treasury Note 2%: 3.99%
  7. US Treasury Note 1.875%: 3.82%
  8. US Treasury Note 1.125%: 3.76%
  9. US Treasury Note 2.5%: 3.69%
  10. US Treasury Note 2%: 3.57%

 STIP (iShares Barclays Capital Treasury Inflation-Protected 0-5 Year ETF) follows the Barclays Capital U.S. Treasury Inflation-Protected Securities (TIPS) 0-5 Years Index (Series-L) and fills the gap as a short-term TIP product. The fund was launched in March 2010. The expense ratio is .20%. AUM equal $205M and average daily trading volume is $20K shares. As of mid-September 2011 the annual dividend was $.01 making the current yield .08% and YTD return 2.19%.  

Data as of September 2011

STIP Top Ten Holdings & Weightings
  1. US Treasury Note 3%:            10.10%
  2. US Treasury Note 2%:            9.99%
  3. US Treasury Note 1.875%:     9.66%
  4. US Treasury Note 2%:            9.07%
  5. US Treasury Note 1.625%:     8.70%
  6. US Treasury Note 0.5%:         8.45%
  7. US Treasury Note 1.875%:     7.93%
  8. US Treasury Note 2%:            7.75%
  9. US Treasury Note 1.25%:       6.37%
  10. 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.

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The ETF Digest has current positions in SHY and IEF.

(Source for holding data is from various sponsor websites and other ETF data providers.)
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.

Dave Fry is founder and publisher of ETF Digest, Dave's Daily blog and the best-selling book author of Create Your Own ETF Hedge Fund, A DIY Strategy for Private Wealth Management, published by Wiley Finance in 2008. A detailed bio is here: Dave Fry.