The market volatility since the start of the COVID-19 crisis has highlighted one of the main reasons why investors own bonds: potential for principal protection. When the crisis first started in March and April, investors began to drastically shift their portfolios to cope with the new environment. As a result, short-term U.S. Treasuries have been a popular investment given the potential stability they can provide. Given their newfound popularity, let’s take a closer look at this critical sector of the bond market.
Return ON principal vs. return OF principal
Income generation and principal protection are two common fixed income objectives that are constantly at odds. If you’re aiming for principal protection, then short-term Treasuries such as Treasury bills (T-bills) may be right for you. While right now they don’t provide the yield potential as other securities, they have the advantage of being one of the lowest risk investments available.
Why? They have almost zero credit risk—they are backed by the full faith and credit of the U.S. government—and are typically not very sensitive to interest rates because they come in maturities of anywhere between one month and one year.
U.S. Treasury supply is ramping up to meet demand
The U.S. Treasury Department has responded to the investor demand for T-bills by increasing net issuance to $1.5 trillion compared to $77 billion in 2019. As you can see in the chart below, the net issuance in 2020 is about to double from the levels in 2008—underscoring investor demand for principal protection.
In April 2020, demand for T-bills spiked and something unheard of happened—they briefly had negative yields in the secondary market. Why? An onslaught of investors seeking the protection of government securities pushed prices up and yields down. Going forward, we believe the increase in issuance should help keep short-term Treasury rates positive. You can view the Treasury auction results on a publicly available website here.
Less vanilla than you think
Although U.S. Treasuries are often seen as boring by investors who tend to see news headlines focused on corporate and high yield markets, the Treasury market is actually a very diverse and dynamic place. The U.S. government tends to change its supply patterns based on funding needs, current market rates and investor demand. At times, they will even introduce new securities types.
As you can see in the figure below, T-bills are currently about 22% of the $18 trillion of U.S. Treasuries issued. The largest component is Treasury notes at 54.9% and have maturities of 1-10 years, followed by Treasury bonds at 13.2%, which have maturities over 10+ years. The U.S. Treasury also began issuing a 20-year maturity bond this month for the first time since 1986. Treasury Inflation-Protected Securities (TIPS) provide investors protection against changes in inflation, which were first introduced in 1997 and comprise about 8.1% of U.S. Treasury issuance. In 2014, floating rate Treasury notes (FRNs) were introduced, providing investors with the option to invest in Treasuries whose coupon adjusts based on the prevailing interest rates, and are just 2.3% of the total U.S. Treasury issuance today.
Bond ETFs: An easy way to tap into U.S. Treasury markets
Bond ETFs have been a popular way for investors to access Treasury bonds. As of Apr. 30, 2020, investors have put over $24 billion into short-term U.S. Treasury bond ETFs, including $4.2B and $5.2B in the iShares Short Treasury Bond ETF (SHV) and the iShares 1-3 Year Treasury Bond ETF (SHY), respectively. Based on investor feedback and the continued sentiment that potential stability is important now more than ever, iShares is launching the iShares 0-3 Month Treasury Bond ETF (SGOV) to help clients access ultrashort and highly liquid U.S. Treasuries. SGOV will offer exposure to both T-bills, notes and bonds that have maturities of less than 3 months with at least $1 billion outstanding.
Using an ETF to access short-term Treasuries can help investors stay fully invested. Since the fund continuously holds bonds that mature in 3 months or less, the ETF can help you maintain exposure without having to roll individual bonds yourself. Rolling individual treasury bonds can be operationally intense and time consuming. However, it is important to note that there is no guarantee of principal protection for an ETF as its price can fluctuate based on the value of its underlying securities and/or the supply and demand of the ETF shares themselves.
iShares now offers a full suite of U.S. Treasury Bond ETFs, including term maturity bond ETFs and FRNs. They can be used to:
- Seek to add stability to your investment portfolio: iShares Treasury bond ETFs provide investors access to U.S. government bonds, which are high-quality, AAA-rated securities that can help you seek stability and diversification from equities.
- Customize your exposure to interest rate risk: With 20 options available spanning different maturity ranges and target years, iShares Treasury bond ETFs can help you target the duration you seek.
- Stay fully invested: iShares Treasury bond ETFs can help investors maintain exposure to the Treasury bond market. The ETFs are balanced monthly by the portfolio management team to keep the funds exposed to the specific part of the Treasury market as specified in the funds’ investment objectives, such as 7-10 years or 0-3 months.
Karen Schenone, CFA, is the Head of U.S. iShares Fixed Income Strategy within BlackRock’s Global Fixed Income Group and is a regular contributor to the Blog. Ross Pastman, CFA, Associate is a member of the iShares Fixed Income Strategy team and contributed to this post.