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Money and Markets: Investing Insights

Are Any Treasury ETFs Safe?

Ron Rowland | Thursday, July 21, 2011 at 7:30 am

 

Ron Rowland

Your heroes in Washington D.C. are locking horns about the government debt. If they don’t reach a deal very soon, the Treasury may have to stop borrowing money next month.

This is, of course, exactly what the Treasury should have done a long time ago, in my opinion. The national debt is out of control. Instead of making tough decisions, Congress and the White House have stalled for decades. They can’t do this forever — which is why Weiss Ratings downgraded U.S. government debt from C to C-minus last week.

I don’t know how it will all end. But here’s what I do know: If you own Treasury ETFs, you’re on the wrong end of a potentially bad loan. We can no longer assume that U.S. government debt carries no credit risk.

They get a C-minus.
They get a C-minus.

 

On the other hand, what are the alternatives? Exactly what else are you supposed to do with your cash? We don’t have many good choices.

Last week I told you how to use duration to assess the risk of rising interest rates. As I said, credit risk is different. There is a connection, though. Smart lenders keep risky borrowers on a tight leash — the tighter the better.

If you must loan your money to a shady character, then you at least want to get your cash back as soon as possible. You do this by keeping your maturity and duration short.

I totally agree with Martin’s latest assessment: Avoid medium- and long-term U.S. government securities. That includes Treasury ETFs with average duration of more than 1-3 years. And you probably ought to stay on the shorter end of that scale.

Even short-term Treasury ETFs aren’t free of credit risk or interest rate risk. And the yields aren’t exactly impressive, either. But conservative investors should take a look, anyway.

What Is “Short-Term?”

This may seem like a simple question, but it’s an important one. Treasury securities are issued with maturities as short as three months and as long as thirty years — plus various points in between.

ETF sponsors know investors usually want to stick with one part of the yield curve. I like the way iShares breaks it down. They have six Treasury bond ETFs. The most conservative, SHV, keeps its portfolio maturity at one year or less. Their other five offerings cover ranges of 1-3 years, 3-7 years, 7-10 years, 10-20 years, and 20+ years.

Some people would disagree with me on this, but I think it’s fair to describe bonds maturing in three years or less as “short-term.” A stricter definition might include only maturities of one year or less. Whichever definition you chose, you can use ETFs to match your investments to your desired time frame.

Six Short-Term
Treasury ETFs

As we saw last week, short-term Treasury ETFs are yielding next to nothing. However, in the current environment, we’re not buying them for income, we’re buying them for relative safety. Here are six ETFs that you may want to consider:

  • SPDR 1-3 Month T-Bill Fund (BIL)
  • Schwab Short-Term U.S. Treasury ETF (SCHO)
  • iShares Short-Term Treasury Bond Fund (SHV)
  • Vanguard Short-Term Government Bond Index Fund (VGSH)
  • iShares 1-3 Year Treasury Bond Fund (SHY)
  • PIMCO 1-3 Year Treasury ETF (TUZ)

A few of these ETFs are eligible for commission-free trading at various brokerages (SCHO at Schwab, SHY at Ameritrade, and VGSH at Vanguard). Contact your broker for details.

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Should You Hedge
Your Treasury ETFs?

Treasury ETFs of any category are, of course, indirectly tied to the fate of the U.S. dollar. The negative impact of a falling greenback may not be readily apparent, but it’s still there. Hence you may also want to consider hedging your currency exposure.

 

Gold is the ultimate currency hedge.
Gold is the ultimate currency hedge.

 

A good way to do this is with a gold bullion ETF — one based on the actual metal, not shares of mining companies. Gold is likely to move up quickly in any weak-dollar scenario, so having a small slice in a gold ETF is a good insurance policy.

SPDR Gold (GLD) was the original gold ETF and is still the largest. iShares Gold (IAU) is also a good choice. One handy thing about IAU is that each share represents 1/100 ounce of gold. GLD shares are tied to 1/10 ounce. Therefore, investors may find it easier to get the precise allocation they want with IAU.

I sincerely hope Washington gets its act together and the U.S. avoids default. Meanwhile, now is a good time to review your Treasury holdings and possibly shift your exposure to the short end. The ETFs I named above can help you do it.

Best wishes,

Ron

P.S. The U.S. isn’t hopeless. But the rest of the world is full of even better opportunities, which are what I seek out for my International ETF Trader members. To learn how you can join them, risk-free, click here.

 

Ron Rowland is widely regarded as a leading ETF and mutual fund advisor. You may have read about Mr. Rowland and his strategies in publications such as The Wall Street Journal, The New York Times, Investor's Business Daily, Forbes.com, Barron's, Hulbert Financial Digest and many more. As a former mutual fund manager from 2000 to 2002, Ron was a pioneer in using ETFs inside of mutual funds. Today, he is the editor of International ETF Trader, dedicated to helping investors use ETFs to profit from ever-changing global market conditions.

{ 7 comments }

john bloodworth Thursday, July 21, 2011 at 7:50 am

Ron: You completely ignored TBT in this article. you avoided any postion statement relative to this ETF even though Martin has been recommending for two years. With QE2 ending recently you should have had some postion relative to this ETF. Disappointed…John B

Ron Rowland Thursday, August 4, 2011 at 9:07 am

John, the intent of this article was to point out the safest Treasury ETFs. To me, that means short-term Treasurys. TBT is long-term, it is leveraged, and it is inverse. TBT is a speculative play, not a safe short-term Treasury ETF.

Ed Thursday, July 21, 2011 at 8:15 am

Ron,

Weiss downgraded US government debt to a C-. Does this mean that a Weiss-rated bank at “B” is safer than US treasuries?

What will happen to the FDIC insurance if the debt ceiling is not increased?
If a bank goes bankrupt while the debt ceiling has not increased, will the people with savings in that bank lose their money even though the account is FDIC-insured?

Thank you.

RICK Thursday, July 21, 2011 at 9:02 am

Great Question ED!
What will happen to I-Bonds in the event of US Govt default?

Ron Rowland Thursday, August 4, 2011 at 9:19 am

Ed,

I am not an FDIC expert, but I’m under the impression that it is backed by a separate fund instead of counting on new funding from the sale of Treasury securities. Of course, long term, that fund would diminish and have to be replenished somehow.

Fortunately, this time around, we did not have to see what would happen in a US default. I hope we never will. I think there are far too many variables to predict which items would be impacted first and the most. As we saw, everything is at the mercy of the politcal process and new priorities and rules/regulations can be made up on the spot.

Jim B Thursday, July 21, 2011 at 10:44 am

Ron: How does one sort out what ETFs have derivative exposure?

Ron Rowland Thursday, August 4, 2011 at 9:13 am

Jim,

You can start with this article I wrote a while back:
http://www.moneyandmarkets.com/does-your-etf-own-derivatives-41439

However, you will have to go to the ETF’s website and look at the holdings to get the final/best answer.

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