PLW - PLW: A Clean Way To Buy The Yield Curve

2023-04-23 05:13:46 ET

Summary

• The Invesco 1-30 Laddered Treasury ETF is a Treasuries fund.
• The vehicle is entirely composed of AAA Treasuries, and holds equal weight amounts of treasuries across the tenor spectrum.
• Rather than speculate on the moves of a given point in the curve, a retail investor can take a view on the entire curve.
• As the Fed is set to cut rates in 2024, we expect the entire curve to shift down.
• The fund is rebalanced and reconstituted annually in February.

Thesis

Many times retail investors have a hard time accessing instruments and returns which are available to institutional investors only. Think derivative instruments here and many customized swaps. The rates space is one which is aggravatingly opaque to retail participants. We have all read about the historic inversion in the 2s/10s points in the curve but there is no tool for an investor to bet on that. There are many rates trades that purely exist for institutional investors unfortunately. Betting on the yield curve is not one of them.

The Invesco 1-30 Laddered Treasury ETF ( PLW ) allows a retail investor to express a view on the yield curve in an exchange traded fashion. The yield curve is exactly what you see in the article's main picture, i.e. a curve representing treasury yields dependent on their maturity date. Let us have a look at how the current curve plots versus the January 2022 one:

The red curve is the current one while the blue one is the yield curve as of January 3rd, 2022. Quite the change!

It is no secret that yields skyrocketed as the Fed raised rates, but it is quite interesting to see how the front end of the curve got literally smashed (yields moved from 10 bps to 500 bps) while the long end shifted higher by 200 to 300 bps.

As yields rise and the treasury curve shifts up, bond prices go down. This resulted in 2022 being a massive draw-down year for fixed income instruments, credit-risky and risk-free ones alike. We believe we are now close to peak rates, and 2024/2025 are going to be years where the Fed cuts rates rather than increase them. To that end bond prices will subsequently move up. Each point in the yield curve has a duration associated with it and a predicted price move as rates come down. The magnitude of the move is going to be determined by duration. We have written a number of pieces regarding funds that take views on certain points of the curve:

• The iShares® 0-3 Month Treasury Bond ETF ( SGOV ) which we covered here (Short End of the Curve)
• The Vanguard Extended Duration Treasury ETF ( EDV ) which we covered here (Long End of the Curve)

The Invesco 1-30 Laddered Treasury ETF is a fund which covers the entire yield curve via its construction. So it is not an expression of what a certain point in the curve will do, but what the entire line will look like (shift up or shift down).

Holdings

The fund holds equal weight amounts of treasuries across the tenor spectrum:

We can see from the above table that only the 10 year point and 13 year point have 6.7% weightings, the rest of the bonds having 3.35% allocations. This basically translates into the fund having returns that are akin to the move in the entire curve.

A retail investor can most certainly just replicate the holdings by buying each individual CUSIP rather than paying the 0.25% annual expense ratio. The results would be the same, however they would experience time decay if they did not roll the CUSIPs every year. The ETF does this for you:

The Invesco 1-30 Laddered Treasury ETF is based on the Ryan/NASDAQ U.S. 1-30 Year Treasury Laddered Index (Index). The Fund will normally invest at least 80% of its total assets in US Treasury securities that comprise the Index. The Index measures the potential returns of the U.S. Treasury yield curve based on approximately 30 equally weighted U.S. Treasury issues with fixed coupons, scheduled to mature in a proportional, annual sequential ("laddered") structure. The Fund and the Index are rebalanced and reconstituted annually in February .

This just means that after 1 year the 10 year Treasury will become a 9 year Treasury due to time decay, and the ETF will roll into the new 10 year note. This way it maintains a constant exposure to the entire curve. A savvy and active investor can most certainly do that 'roll' themselves if they want to.

Expected Performance

The fund lost almost -20% in 2022 as yields moved up and the entire curve shifted upwards:

The vehicle is now yielding 3.47% and is going to continue to pay a nice dividend yield for the next two years.

We expect the Fed to start cutting rates in 2024 and for the curve to shift lower later this year. Timing is hard to pin down given all the current macro developments, but we expect a reversion to front end around 2% in the next 18 months. Coupled with the current dividend yield that translates into a total return upwards of 18% for this AAA fund during the next 24 months.

Conclusion

The Invesco 1-30 Laddered Treasury ETF is a fund that provides an investor with access to the entire yield curve returns. The vehicle is composed of equal weight Treasuries across the tenor spectrum. Rather than take a view on a certain duration point, the fund provides for a return profile consistent with the shift in the entire curve. While a retail investor can replicate this strategy by individually buying each CUSIP in this portfolio, for 0.25% per year the fund rolls the collateral yearly and can represent a nice way to dollar cost average into a return profile. We expect the Fed to cut rates next year and for the yield curve to shift down. We see PLW providing a nice 18% plus total return during the next 24 months.

For further details see: