Market Pulse: Reward-free risks
Special to the Tribune
The rapid rise in interest rates this year has exposed the risk in Treasury bond funds that many thought were safe. Yes, the U.S. government is a very highly rated borrower, but there is risk of another kind. Funds like the iShares 20+ Year Treasury (TLT) are almost a guaranteed loser.
It is hard to make a case for Treasurys. Why? The 10-year Treasury yields 1.52%, yet inflation over the next decade will surely average more. And you have to pay taxes on the interest as well if they are owned outside of an IRA. Those buying a 10-year Treasury today may incur a real (after inflation) loss. That makes no sense.
It’s even harder to make a case for a Treasury fund or ETF, because unlike an individual bond, where a holder knows what to count on at maturity, a fund never matures. As individual issues mature the fund manager replaces them with newer ones. That means as interest rates rise, the price of a fund can fall and fall (bond prices move inversely with interest rates), more than offsetting the small interest payments. We’ve seen that many times.
How much can a bond fund fall? Look at recent activity for iShares 20+ Year Treasury ETF (TLT). It has lost 11% this year and is down 20% since last August. Meanwhile it only yields 1.6%. There is real risk but very little reward.
Many other fixed-income funds are vulnerable to rising rates. The iShares Investment Grade Corporate Bond ETF (LQD) has lost 6% this year. But junk bond funds are tied more to the strength of the economy than they are to rising interest rates. That’s why SPDR High Yield Bond ETF (JNK) hasn’t dropped this year. Since interest rates are rising, I prefer a high-yield fund with shorter maturities. My favorite is SPDR Short Term High Yield ETF (SJNK).
Bottom line: Those who own Treasury funds for safety are misinformed, misguided, or mistaken. Their investment is riskier than they think but not due to concerns about Uncle Sam’s credit worthiness. With such low interest rates, there is little upside for the fund’s price and potentially a lot of downside. Risk-free investments? No, reward free risk.
David Vomund is an Incline Village-based Independent Investment Advisor. Information is found at http://www.VomundInvestments.com or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.
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