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Summary TLO offers investors a low expense ratio and a negative beta. The average effective duration is around 17 years but the actual breakdown on securities is in the 10-15 range and heavily in the 20 to 30 year range. Negative correlation with major equity investments makes TLO an intelligent choice for diversifying the portfolio. For investors that are going heavy on bond funds, I would start with SCHZ and then add on TLO as a second option. For investors going heavy on equity and only using bonds for diversification, I would start with ZROZ and then use TLO as the secondary option. The SPDR Barclays Long Term Treasury ETF (NYSEARCA: TLO ) is an option for investors seeking exposure to the longer portion of the treasury yield curve. This kind of allocation can be used for an investor seeking interest income (2.6% yield) and willing to take on duration risk. However, I think the best use of this fund by a significant margin is to use it in a portfolio that goes overweight on equity securities and uses regular rebalancing to take advantage of the highly negative correlation between TLO and the major market indexes. Expense Ratio The fund has an expense ratio of .10% which is very solid for bond ETFs. I’d still like to see it get into the single digits because I’m very frugal with expense ratios, but I wouldn’t complain about including an ETF with a .10% expense ratio in my portfolio. Quick Figures Over 99.8% of the holdings of the security are invested in domestic government debt. This is quite simply a quick way to get government debt into your portfolio without paying high trading costs. Rationale If the purpose of the position is to keep the portfolio properly balanced and reduce the volatility of the portfolio, then it makes sense to treat trading costs as a major issue due to rebalancing. TLO is one of the options on Schwab’s free ETF trading system which was a major reason for it going onto my short list of treasury ETFs. Fixed Income Statistics The statistics below provide a rough idea of the numbers on the portfolio. The bonds trade at a substantial premium due to having higher coupons. (click to enlarge) While those numbers are useful for an initial impression, I think it is important to also look at the breakdown along the yield curve because this is not a bullet fund where the bonds are all maturing in a very tight date range. Maturity The SPDR Barclays Long Term Treasury ETF is primarily using the 20 to 30 year debts but also contains a material allocation to the 10 to 15 year range. (click to enlarge) Having a small allocation to the 10 to 15 year range should make TLO less volatile than some other treasury security ETFs. On one hand that is a positive factor in isolation but for investors using their bond allocation strictly for negative correlations the longest exposures and higher volatility can produce the appropriate hedge against equity volatility with smaller allocations. Building the Portfolio I put together a hypothetical portfolio using only ETFs that fall under the “free to trade” category for Charles Schwab accounts. My bias towards these ETFs is simple, I have my solo 401k there and recently moved my IRA accounts there as well. When I’m building a list of ETFs to consider I want to focus on things I can trade freely so that I can keep making small transactions to buy more when the market falls. Within the hypothetical portfolio there are no expense ratios higher than .18%. Just like trading costs, I want to be frugal with expense ratios. The portfolio is fairly aggressive. Only 30% of the total is allocated to bonds and I would consider that the weakest area in the portfolio. I’d like to see more bond options (with very low expense ratios) show up on the “One Source” list for free trading. (click to enlarge) A quick rundown of the portfolio The Schwab U.S. Dividend Equity ETF (NYSEARCA: SCHD ) is a dividend index. The Schwab U.S. Broad Market ETF (NYSEARCA: SCHB ) is a broad market index. The Schwab U.S. Large-Cap ETF (NYSEARCA: SCHX ) is focused on blended large cap exposure. The Schwab International Equity ETF (NYSEARCA: SCHF ) is developed international equity. The Schwab Emerging Markets ETF (NYSEARCA: SCHE ) is emerging market equity. The Schwab International Small-Cap Equity ETF (NYSEARCA: SCHC ) is developed small capitalization equity. The Schwab U.S. REIT ETF (NYSEARCA: SCHH ) is domestic equity REITs. The Schwab U.S. Aggregate Bond ETF (NYSEARCA: SCHZ ) is a remarkably complete bond fund. is a long term treasury ETF. The PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF (NYSEARCA: ZROZ ) is an extremely long term treasury ETF. Notice that the 3 international equity ETFs have only been weighted at 5% while the broad market index has been weighted at 25%. I find heavy exposure to international equity to bring more risk than expected returns so I try to keep my international exposure low. I prefer no more than 20% in international equity. Plenty of domestic companies already have enormous international operations so the benefit of international diversification is not as strong as it would be if the markets were isolated from each other. Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. When TLO and ZROZ post negative risk contribution it is because the negative correlation to most of the equity holdings results in the long term treasury ETFs reducing the total portfolio risk. In my opinion, this is the best argument for including them in the portfolio. Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio and with the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ). Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. (click to enlarge) Conclusion TLO and ZROZ post fairly similar numbers on negative correlations and if I was simply using the ETF for producing some income it would be easy to select TLO over ZROZ. On the other hand, because the correlations are so negative, higher volatility in the ETF can become an attractive feature. The quickest way to demonstrate this factor is to look at the negative beta for each ETF. On TLO the beta is a negative .49 and on ZROZ the beta is a negative .90. TLO is a good option with rebalancing to make a steadier portfolio value. For the simple purpose of stabilizing portfolio values I think ZROZ a quicker way to accomplish my goal because I can use a smaller allocation to the bond ETF to maintain the negative beta exposure that reduces the overall volatility of my portfolio. If an investor wants more bond allocations, then I think they should start with diversified exposure like SCHZ and then look to add TLO before adding ZROZ. If the goal is simply creating negative beta for the portfolio, the order of the ETFs would be reversed with investors favoring ZROZ, then TLO, and finally SCHZ. Disclosure: I am/we are long SCHB, SCHD, SCHF, SCHH. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis. Scalper1 News
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