Bond ETF Investing And The Debate Over Long-Term Treasuries: Don’t Get Distracted.

Aug 29, 2010

We have watched with amusement all the discussion of bond ETF investing as it relates to ‘bubbles.’  Remember that the bond market as defined by the Aggregate Bond Index has a duration[1] in the 4-5 year range.   This is where the real investable bond market is – not 30 year treasuries.  

Indeed, by our ETF database (which covers >96% of overall ETF/ETN assets), we see that less than 10% of total treasury bond ETF assets are in bond funds with durations greater than 10 years.  Our overall weighted average estimate of the duration of ETF investors aggregate duration in the Treasury bond grouping is 4.9 years.

Now, it IS true that the risk of drawdown for 10- 30 year bonds becomes more significant after a parabolic spike up like the one we have been in – but this should be obvious as this is just the nature of volatility.   Long duration bonds are very volatile securities – and when a highly volatile security goes parabolic, drawdown risk will increase.  We find it irrelevant and distracting to listen to this talk of bond bubbles and more practical to think in terms of actual drawdowns within the bond market sub-segments.    

Here is an ETF Volatility Chart of relative volatilites across some different kinds of ETFs. We included IEI (~4-5 year duration U.S. Treasury ETF) because it represents the weighted average duration of all Treasury bond ETF investor assets:



[1] Duration measures how fast you are to be paid your money back.  It adjusts for the stated coupon so that if your bond pays a high coupon, the duration is lower as you are being repaid more quickly and therefore the variability of possible cash flows is reduced. 



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Comments (2) -

Aug 29, 2010 15:37 #

Very helpful.  I don't really think that a bubble in bonds is likely - people are buying safety, not returns.  Most if not all of the previous bubbles were based on people pouring into asset classes to make "easy money".  Who is buying bonds under that asumption?  Most are simply looking at them as a safe haven until other asset classes provide better returns (translation - stop losing money).

Kevin_in_GA United States

Aug 29, 2010 20:21 #

If you run charts on JNK and TLH and BIV/LQD, you can see how these bond market segments offer investors some solid choices with regard to fixed-income.   These ETFs have just enough volatility to offer some tactical opportunities -- but not so much as to dominate your portfolio.  

Bond ETFs can provide a nice complement to other more aggressive strategies such as an equity-oriented country fund strategy.

Chris United States

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