Richard Bernstein, the long-time market strategist from Merrill Lynch, has said many times that ‘U.S. Treasuries are the only true diversifying asset.’ We wanted to make a few more specific comments that add to the discussion with regard to US Treasury ETFs.
First, there is a very large difference between a short or intermediate 3-7 year type of treasury security and a 10-30 year long-term bond. The term ‘US Treasury’ is too vague to actually be practical. The short and long-term Treasury ETFs are really entirely different categories of securities.
The ETF world has securities all up and down the maturity spectrum. Let’s look at an extreme example to help understand what we are talking about: EDV (the Vanguard Extended Duration ETF) had a very large -41% high to low daily closing move (drawdown) in 2009. ‘Maximum drawdown’ is a nice, easy way to think about ‘risk’ --- everyone can understand it intuitively: When this asset class goes down, how much does XYZ go down vs others in the same asset class?
At the same time EDV was dropping -41%, the iShares 3-7 year Treasury bond ETFs largest drawdown was -6%. Maximum drawdown is the amount of loss if you bought the exact closing high and sold the subsequent exact closing low (the worst trade possible based on closing prices). While certainly far from perfect, this is a useful way for investors to at least incorporate some type of risk analysis into their thinking. Discussing returns without the context of risk is a common error made by investors across all segments of the industry.
As a general rule, you should avoid the highest volatility securities as these will tend to have the largest drawdowns -- and the ultimate goal is to think in terms of reward and risk – not just return.
Long-term bonds are quite tricky to analyze, given their low yields and highly volatile nature. Intermediate-term bonds (treasuries and non-treasury bond ETFs) are much more straightforward. If your timing is off, the penalty for this is much lower as this maturity zone won’t drop much when the equity markets are rising. But more importantly, this group will offer a nice hedge for nearly any other security you hold.
This table summarizes a list of U.S. Treasury ETFs and their Maximum drawdowns over the past few years:
Note: EDV had a very large capital gains distribution in 2009. Be aware that if you look at this on a regular charting platform that doesn’t adjust ETF for total return, the chart will not be representative of the underlying index that the ETF is tracking.
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