Crumbling global equity markets have been the story of recent weeks, as investors around the world endure increased levels of volatility related to Europe’s deteriorating fiscal situation and concerns over government debt levels. Furthermore, tame inflation and a stronger dollar has tempered demand for inflation-protected securities as well as most precious metals. These recent events in the market have sent many investors running to the relative safety of Treasury bonds, especially long-term securities. This dash has driven down rates virtually across the board, sending bond prices sharply higher as a result. From May third to May 20th, the 1-year rate declined from 0.43% to 0.34%, while the ten year rate declined by 47 basis points and the the 30 year bond fell by 40 basis points. This sharp decrease in interest rates had a huge effect on many bond funds, but especially those that have the longest duration.
Duration is a measure of how long, in years, it takes for the price of a bond to be repaid by its internal cash flows. It is an important measure for investors to consider, as bonds with higher durations carry more risk and have higher price volatility than bonds with lower durations. As a result, two Government Bond ETFs with ultra-long durations, Vanguard Extended Duration Treasury ETF (NYSEARCA:EDV) and PIMCO 25+ Year Zero Coupon U.S. Treasury Index Fund (NYSEARCA:ZROZ), have been among the best performers over the past month as equity markets have tanked and investors have piled into bonds. EDV, with an effective duration of 26.4 years is up about 15% over the past month while ZROZ, with an effective duration of 30 years, soared higher by 18% over the same period.
Another long-term bond fund hasn’t performed quite as well, but is still up sharply during the recent “correction;” the iShares Barclays 20 Year Treasury Bond Fund (NYSEARCA:TLT), which has a duration of just under 15, was only up about 9% over the past month.
These big gains aren’t compatible with the notion many investors hold regarding the stable nature of long-term bonds; in the current environment these securities are quite volatile. Because this volatility has been in the opposite direction of equity markets, ETFs like EDV and ZROZ have been effective at smoothing out the overall fluctuations in portfolios in recent weeks. But with interest rates having nowhere to go but up, some investors wonder if it’s now time to shift into shorter-term bonds that may not offer the same return potential but will generally deliver more stability.
Disclosure: No positions