SGOV - SGOV: This Ultra-Safe And High Yield ETF Belongs In Most Portfolios

2023-06-16 05:54:30 ET

Summary

• SGOV offers a 5.1% yield with very low risk, making it an attractive investment option in the current economic environment.
• Combining SGOV with VCIT can provide investors with both a high yield and potential capital appreciation.
• I rate SGOV a Buy.

The iShares 0-3 Month Treasury Bond ETF (SGOV) is a cash alternative that currently offers high yield and very low risk. With AUM of about $10.5B, SGOV has a 30-day SEC yield of about 5.1%. I recently covered VCIT , Vanguard's intermediate-term corporate bond index, and gave it a Buy rating. My investment thesis was that you can profit off the high yield for now, but also from capital appreciation once rates start to go back down. I still stand by my VCIT Buy rating, but after Fed Chairman Powell gave more insight into the future of interest rates, I think there are some valuable ways to use SGOV by itself but also in combination with VCIT. I rate SGOV a Buy.

Holdings

SGOV holds ultra-short-maturing fixed-income US treasury bonds. This ETF only has 16 holdings. This relatively low number of holdings really doesn't pose much threat, considering they are ultra-low-risk assets. SGOV's top 10 holdings make up about 80% of its AUM.

SGOV excludes inflation-linked securities, zero-coupon bonds, and cash management bills. Because SGOV doesn't reinvest coupon payments, the fund manager can choose to put the coupons into money markets, futures, options, swaps, and cash alternatives. These non-treasury assets will never account for over 10% of its AUM.

Why SGOV is so attractive right now

Short-term treasury yields are currently at a two-decade high.

SGOV is currently paying out 5.1%, almost entirely risk-free, and the current yield is expected to go up. Fed Chairman Powell announced that after a June pause, there will be likely two more rate hikes in 2023. This will cause short-term rates to go up even more. Because short-term treasuries' prices have low sensitivity to rates, the rate increase will cause only very minimal capital depreciation.

This risk-reward ratio is what investors look for. SGOV gives the opportunity of a 5+% return with practically zero risk. The timing for this opportunity is also great. With a recession on the way, in my opinion, SGOV provides a place to park cash to wait out the economic turmoil, while still having an impressive yield. By itself, SGOV is a great asset to buy right now, despite one major shortcoming.

Where SGOV falls short

As every bond investor knows, when rates go up, the bond prices go down, and when rates fall, the prices go up. Eventually, after the economy slows sufficiently, the Fed will lower rates, and because short-term treasury prices are less sensitive to rates, they won't get the capital appreciation that longer-term bonds will benefit from.

While this is an issue for investors looking for both high yield and possible capital appreciation, this problem won't be an issue for quite some time. Fed Chairman Powell said that rate cuts are " a couple years out ." This means that the capital appreciation offered by longer-term bonds is also a good way off. Although SGOV doesn't have a good capital appreciation outlook, it's still a great ETF to own right now, and I think there is a way to use SGOV while still benefitting from capital appreciation.

SGOV and VCIT

Having the bond segment of a portfolio be a mix of SGOV and VCIT can bring a lot of benefits in the current environment. First, an investor holding VCIT can lower the risk of their portfolio by adding SGOV without sacrificing much yield. VCIT has a 30-day SEC yield of about 5.3%, while SGOV's is barely less at 5.1%. Having a mix of these two ETFs also allows for capital appreciation. When rates start to go down, SGOV will stay about the same in value while its yield goes down. However, because VCIT holds riskier corporate bonds and has a longer maturity time, VCIT will go up in price while its yield goes down. This strategy offers the best of both worlds without making investors try to time the market and predict when exactly the rate hikes will end and when the rate cuts will start. The ratio of SGOV and VCIT should be up to the individual investor's risk tolerance.

SGOV into VCIT

Another potential strategy that involves these two ETFs is buying SGOV now and moving it into VCIT after rate hikes stop. After the two rate hikes that Powell talked about happened, moving money from SGOV to VCIT allows more risk-tolerant investors to profit from capital appreciation, without sacrificing current yield. This strategy allows investors to take advantage of the low-risk, high-yield now, and the higher-risk capital appreciation later.

Conclusion

SGOV provides a low-risk, high-yield cash alternative. Short-term treasury yields are at a two-decade high and have almost no risk, making them a great choice going into a recession, which I expect. Combining SGOV with VCIT gives investors a high yield with a chance of capital appreciation. I rate SGOV a Buy.

For further details see: