VCSH - SPTS: You Should Own Long-Term Treasury Instead

2023-03-28 10:59:17 ET

Summary

• SPTS invests in short-term U.S. treasuries with an average maturity year of 1.93 years.
• While downside risk is limited, SPTS offers little capital appreciation as it has lower rate sensitivity than longer duration treasury funds.
• The yield of SPTS is also not as attractive as 6-month treasury in this inverted yield curve environment.
• Therefore, we think investors should seek alternatives elsewhere.

Introduction

When it comes to investing in U.S. treasuries, we need to also consider its duration. Should it be better to invest in shorter duration treasury funds or longer duration treasury funds? In this article, we will analyze SPDR Portfolio Short Term Treasury ETF ( SPTS ) and offer our insights and suggestions.

ETF Overview

SPTS owns a portfolio of short term U.S. treasuries with an average maturity year of 1.93 years. The fund has limited downside risk as the Federal Reserve has already indicated that we are near the end of this rate hike cycle. However, the fund's upside potential is also limited as its fund price has a low sensitivity to rate changes. Therefore, if the Federal Reserve ever lower the rate, it will not see any meaningful upside either. Hence, we believe investors should seek other alternatives.

Fund Analysis

SPTS actually performed better than its longer duration peers last year

The bond market has suffered one of the worst years in 2022 due to the Federal Reserve’s aggressive rate hike to combat inflation. As can be seen from the chart below, SPTS suffered a decline of about 3.5% since the beginning of 2022. While the performance was negative, this was a lot better than its longer duration peers SPDR Portfolio Long Term Treasury ETF ( SPTL ) and SPDR Portfolio Intermediate Term Treasury ETF ( SPTI ). SPTL and SPTI declined by 26.43% and 9.08% respectively. The reason why SPTS had much lower decline than its longer duration peers SPTL and SPTI is because of its shorter duration treasuries in its portfolio. In general, the longer the duration of treasuries in its portfolio, the more sensitive its fund price is to the rate change. Hence, SPTL and SPTI suffered much more losses than SPTS.

Downside risk is low

Looking forward to the future, we do not anticipate much more downside risk in the rest of 2023 as the Federal Reserve has indicated that we are near the end of this rate hike cycle. Perhaps there may be one more rate hike to go and that will be about it. While some may argue that there will be a recession coming up, SPTS should not be impacted negatively. As can be seen from the chart below, the fund price of SPTS suffered no loss during the recession caused by the outbreak of the pandemic in 2020. In contrast, Vanguard Short-Term Corporate Bond Index ETF ( VCSH ) which has a portfolio of short-term corporate bonds suffered a negative spike during the outbreak in 2020. This is because U.S treasury is often perceived as risk-free asset. When the market is in a panic mode, money tend to flow out of riskier assets such as corporate bonds into U.S. treasuries.

If you are seeking higher yield, there are still better choices

As can be seen from the chart below, we are currently in an inverted yield curve environment where longer duration treasury yield is lower than shorter term treasury yield. In this environment, owning shorter term treasury is the better choice if the goal is to only earn interest income. The additional benefit of owning shorter term treasury is that their prices are less sensitive to the change of rate.

The problem is that SPTS currently has an average maturity year of 1.93 years. While the yield of SPTS is better than intermediate treasury funds that typically have an average maturity year between 7 and 10 years, its yield is still lower than other shorter duration treasuries such as 3-month or 6-month treasury. As can be seen from the chart below, 3-month and 6-month treasury currently have yields close to 4.8%. Therefore, if earning interest income is the investor's primary objective, SPTS may not be the best choice. Why not own 6-month or 3-month treasury funds instead? They offer higher yields and have even lower rate risk than SPTS.

If you are seeking capital appreciation, why not own longer duration treasury ETFs instead?

If one’s goal to own SPTS is to seek capital appreciation, this fund is not the right choice as the fund is less sensitive to rate change than longer duration treasury funds. Given that this rate hike cycle is likely near the end, downside risk is likely limited for both shorter and longer duration treasuries. On the other hand, if the Federal Reserve ever decides to lower the rate in the future, longer duration treasury funds should experience meaningful capital appreciation. At the moment, it looks like treasury funds that have an average maturity year of 20 years is the better choice. As the chart above shows, 20-year treasury offers higher yield among longer duration treasuries. SPTL, which has an average maturity year of 23.2 years, appears to be the better choice. Not only does it have similar yields than SPTS, it has the potential to gain meaningful capital appreciation beyond 2024.

Investor Takeaway

For investors wanting interest income, we think there are better choices. On the other hand, for investors seeking capital appreciation, we think longer duration treasury funds such as SPTL may be the better choice. Either way, SPTS does not appear to be beneficial. Therefore, we think investors should seek alternatives elsewhere.

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