Scalper1 News
Summary The Vanguard Extend Duration Treasury ETF gives investors exposure to the very long end of the yield curve. The yield is material but the price swings on long duration treasuries easily dominate the yield in determining annual returns. I won’t be surprised if the Fed hikes short term rates in December, but I don’t think they can continue to push up short term rates after that. If investors buy into the Federal Reserve’s picture, there could be some great sales on long duration treasuries. The Vanguard Extend Duration Treasury ETF (NYSEARCA: EDV ) is a solid option for exposure to treasuries. The ETF has an expense ratio of only .12%. As I’ve been searching for appealing bond funds, I’ve found some of my favorites are from Vanguard. Given my distaste for high expense ratios, it should be no surprise that the Vanguard products would be appealing. After looking through the portfolio, I think the holdings are fairly reasonable for an investor wanting to regularly keep part of their portfolio in a bond fund. Quick Introduction The Vanguard Extend Duration Treasury ETF is showing a yield to maturity of 3.0% and an average effective duration of 24.6 years. This isn’t an investment that investors should take lightly when it comes to interest rate risk. In my opinion the big reason to use such long duration securities is to reduce total portfolio volatility due to the negative correlation with the market or to make a play on long term yields falling and creating substantial capital gains. Maturities I grabbed another chart to show the effective maturity on the securities: That shouldn’t be surprising given that the effective duration of the fund was running almost 25 years. December The reason I’m looking to keep an eye on the very long duration securities in December is because of the Federal Reserve’s constant pressure to try to increase rates. If they actually get the short term rates higher there may be a shift up across the entire yield curve. The greatest price volatility would come from the long duration bonds. To avoid sensitivity to credit risk, I may opt to use treasuries rather than corporate securities. The Rate Issue The Federal Reserve has been talking for years about raising rates and they finally got some ammunition in November when the “jobs report” came out and indicated that unemployment levels were lower than expected and lower than the previous measurement. The Federal Reserve has an opening and they could use this opportunity to push interest rates higher. I think there is a fairly significant chance of that happening. The latest probability numbers from the CME Group, which uses the “Fed Funds Futures” to track implied probability, is shown below: (click to enlarge) We’re expecting around a 70% chance of short term rates getting a slight boost. I don’t believe that the Federal Reserve can continue to raise rates in the manner that they would like to, but I do think that an increase in short term rates finally happening could create a serious hit in the value of long term treasuries as investors start to buy into the idea that the United States will be creating higher interest rates on treasuries while most of the developed world is showing significantly lower rates. I wouldn’t be surprised if the Federal Reserve raises rates in December and sends bond prices falling. If that happens, I would consider it more likely that they would be forced to go back down on rates in 2016 rather than being able to raise them again later in the year. If short term rates went back down, I think it would be an admission of the difficulties of raising rates in this environment and the 30 year yields would fall. A falling 30 year yield would push prices on EDV materially higher. Conclusion This is a great treasury ETF with a low expense ratio and it should be on the “watch list” for investors going into December. If the Federal Reserve manages to raise rates and the 30 year yields rise (prices fall) materially, then I think it will become a fairly attractive option. I’ll be looking at long duration treasuries in December as a possible way to reduce my portfolio volatility and capture some significant gains if rates fall back down. Over the last year, EDV has had a negative correlation with the S&P 500. This wasn’t a slightly negative correlation either, this was -.41. This serves as potentially a useful hedge against my equity positions while giving me the potential to benefit from falling yields and rising prices if the Federal Reserve is unable to follow through on their plans to raise rates. My view on price movements is a significant chance of prices going lower into December followed by attractive buying opportunities to create capital gains in 2016. Scalper1 News
Scalper1 News