The Vanguard Short-Term Bond ETF Pays 3% With No Exposure To The Stock Market

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About: Vanguard Short-Term Bond ETF (BSV)
by: Vanaheimr Capital
Summary

The Vanguard Short-Term Bond ETF is a highly liquid product with over $50 billion in AUM.

BSV purchases primarily government debt and highly rated corporate debt that matures in less than five years.

BSV is a low-cost ETF alternative to parking your money in a low yield checking account but with the risk of capital loss.

Investment Thesis

With the stock market volatility heating up it makes sense to have cash on hand to purchase opportunistically when the market drops. Although The Vanguard Short-Term Bond ETF (BSV) has the risk of capital loss it is significantly less volatile than higher duration bond and stock ETFs. BSV has an SEC yield of 2.88% as of January 10th and is one of our favorite vehicles to invest cash for the short to intermediate term.

Product Overview

The Vanguard Short-Term Bond ETF is a passively managed index product that tracks the Bloomberg US 1–5 Year Government Credit Float Adjusted Index. The index consists of primarily short to intermediate term US Government treasury bills and notes followed by higher grade corporate credit. US treasuries make up 65% of the portfolio and the lowest rated credits are Baa at just under 13% of the portfolio. The product has a stated goal of 70% treasuries and 30% corporates over the longer term but has the flexibility to deviate slightly from there based on the underlying index weights. The focus on treasuries and higher credit quality ultimately lead to a safer product. Because of the focus on higher credit, the volatility of the product is significantly lower than equity or high yield debt investments. The Vanguard Short-Term Bond ETF has over $50 Billion in assets under management and therefore is a very liquid ETF with low spreads compared to other products. The greater liquidity and lower spreads lead to lower overall transaction costs which benefit investors who transact frequently and or in larger dollar amounts.

Competitor Comparison - ISTB

iShares Core 1-5 Year USD Bond (ISTB) is often compared to the Vanguard Short-Term Bond ETF, but there are some important key differences. ISTB is an index ETF as well and tracks the Bloomberg Barclays U.S. Universal 1-5 Year Index. ISTB has a higher SEC yield of 3.25%, but it achieves this through taking on greater risk. ISTB has $2.3 billion in assets under management which provides investors with ample liquidity. ISTB invests less than 50% of the portfolio in Treasuries and invests 18-20% of the portfolio in BBB and lower corporate credit also known as high yield. The one bright spot is the lower expense ratio of 6 bps for ISTB compared to 7 bps for BSV although ISTB appeared to have a higher bid-ask spread. A very important part of the analysis of ETF transaction costs is to look at the historical bid-ask spread, and in the case of ISTB it has averaged of 0.12% over the past decade while BSV has averaged .02% over the same period. These costs differences can add up dramatically over time.

Competitor Comparison - SPSB

The SPDR Portfolio Short Term Corp Bond ETF (NYSEARCA:SPSB) is even more diverse with its lower duration and bond portfolio that consists of only corporate bonds with maturities in the 1-3 year range while BSV and ISTB hold bonds between 1 and 5 years until maturity. SPSB is also an index ETF and tracks the Bloomberg Barclays U.S. 1-3 Year Corporate Bond Index. SPSB, unlike ISTB, does not look to reach for yield and, like BSV, invests only in Baa and higher rated bonds. SPSB charges an expense ratio of 7 basis points and yields 3.25%. We think SPSB is somewhat of a speculative pick given their exposure to corporate credit and should be viewed as riskier than BSV.

A deeper dive into BSV's holdings

BSV over the longer term will invest 70% of the underlying assets in U.S. Treasuries and the remaining 30% in corporate credit rated higher than Baa. The ETF holds 2554 bonds as of 11/30/2018. BSV invests in short term debt from notable companies like Apple, Goldman Sachs, Oracle, JP Morgan, CVS Health, and GE Capital, just to name a few. No individual company's debt makes up more than a few percentage points in the product, which insulates the investors from credit risk from any single company. 60% of the bonds mature in less than three years as the ETF has an average duration of only a 2.7. The holdings breakdown on Vanguard's website looks incomplete as it doesn't appear to call out the healthcare and technology bonds in the portfolio so we recommend investors look more closely at the holdings to get a better understanding of what they are investing in as we did. The product appears to invest in debt from the majority of the large-cap companies in the S&P 500 and not simply the utilities, industrials, and finance sectors listed below.

Source: Vanguard.com

Conclusion

We prefer The Vanguard Short-Term Bond ETF compared to iShares Core 1-5 Year USD Bond and SPDR Portfolio Short Term Corp Bond ETF given the exposure to higher quality credit and 65% investment in U.S. treasuries which are considerably safer than corporate debt. Although BSV has the risk of capital loss it is significantly less volatile than higher duration bond and stock ETFs. BSV has an SEC yield of 2.9% as of January 4th and is one of our favorite vehicles to invest cash for the short to intermediate term.

Disclosure: I am/we are long BSV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.