VGSH - VGIT: Comparing A Conservative Option With 2 Alternatives

Summary

• I recently revealed that, due to my cautious outlook for 2023, I hold almost 25% cash in my personal portfolio.
• In line with that belief, I have an interest in investments that may offer a nice risk/reward balance in the present environment. VGIT appears to fit that bill.
• In this article, I do an in-depth review of this ETF. I also offer a brief overview of two interesting alternatives, with my analysis of the relative pros and cons.

(This article was co-produced with Hoya Capital Real Estate.)

Back in November, I wrote an article here on Seeking Alpha titled We're In The 5th Inning - That's Why I Hold Almost 25% Cash . In the article, I listed 5 discreet factors that were influencing my view of 2023.

Since that time, the Fed has raised the fed funds rate twice; by 50 basis points in December and another 25 basis points earlier this month. Further, both Jerome Powell himself, as well as other Fed Governors such as Neel Kashkari, have continued to stay on message that we remain in a "higher for longer" rate environment.

In such an environment, I have repeatedly been preaching the mantra of remaining somewhat conservative, and also well-diversified. In other words, that an investor may generate adequate returns while dialing back on the risk profile a little bit.

In that vein, in this article I am going to review an ETF that I feel offers a nice risk/reward balance at the present time. Specifically, this is the Vanguard Intermediate-Term Treasury ETF ( VGIT ). While I will focus on this ETF, I will also offer 2 other options for consideration, both raising the risk level a little bit while offering slightly higher potential returns.

So let's dig in, shall we?

Vanguard Intermediate-Term Treasury ETF - Digging In

First of all, a few basic facts about VGIT. With an inception date of 11/19/2009, the fund is well into its 14th year of operation. As of December 31, 2022, according to VGIT's webpage , it sports AUM of $13.3 billion. Both those numbers speak to a well-established ETF, with a long track record and significant ownership. Like all 3 Vanguard ETFs that I will reference in this article, it carries an extremely low .04% expense ratio.

Here, from VGIT's summary prospectus , is a description of the underlying index for the fund.

The Fund employs an indexing investment approach designed to track the performance of the Bloomberg U.S. Treasury 3-10 Year Index. This Index includes fixed income securities issued by the U.S. Treasury (not including inflation-protected bonds, floating rate securities and certain other security types), with maturities between 3 and 10 years.

Combining this with the low .04% expense ratio I featured earlier, VGIT earns itself a very competitive spot in the marketplace. Take a look at this very interesting comment from Morningstar:

Interest rate and inflation expectations are quickly priced into the Treasury market, making it difficult for active managers to gain an edge and recover their fees without taking greater risk than this portfolio. Fund fees are an important differentiator in the intermediate government Morningstar Category as return expectations are relatively low. With a 0.04% expense ratio for its exchange-traded shares, this fund ranks among the cheapest in its category, which should give it a durable edge over most of its peers.

Next, a nice overview of VGIT's composition, again from the Vanguard website.

I picked this ETF as the centerpiece of this review since, from my perspective, it sits at a nice place in terms of risk/reward in the current environment.

First, let's talk about the fact that it sits, as the name implies, in the intermediate portion of the duration spectrum. While I didn't want to inundate readers with too many pictures, another screen in the same section of the VGIT website shows that 45.60% of VGIT's holdings have an effective maturity of 1-5 years, with the remaining 54.40% falling between 5-10 years. As shown above, this leaves the overall portfolio with an average duration of 5.2 years.

Interestingly, in the present environment, which features an inverted interest rate curve, the current income from Vanguard Short-Term Treasury ETF ( VGSH ) is roughly the same as VGIT. It is also possible that further interest rate increases could cause VGIT to underperform VGSH in the short term. At the same time, if interest rates decrease over the longer term, VGIT offers patient investors more potential for capital gains.

Second, interest-rate risk is really your only risk with this offering. Credit risk is minimal, dare I say virtually nonexistent, because Treasuries are backed by the full faith and credit of the U.S. government.

Briefly Examining Two Alternatives to VGIT

As a reference point, here are two alternative ETFs you could consider depending on your risk tolerance and personal outlook for the next few months. These alternatives are Vanguard Intermediate-Term Corporate Bond ETF ( VCIT ) and Vanguard Long-Term Treasury ETF ( VGLT ).

For a high-level overview of the 3 ETFs, have a look at this compact, yet comprehensive graphic, courtesy of Hoya Capital Income Builder .

As can quickly be seen, both VCIT and VGLT offer between roughly .50% and 1.00% increases in terms of current income. Let's take a quick look at some characteristics of the two, and then talk a little bit about pros and cons.

Let's start with VCIT. Of course, the key difference between this ETF as compared to VGIT is the "G" vs. the "C" in the ticker symbol. This, of course, refers to government bonds vs. corporate bonds. And, unlike a total-market bond ETF such as Vanguard Total Bond Market ETF ( BND ), in which there is a mixture of both, they are mutually exclusive in the two ETFs we are considering.

With that, here's the portfolio composition of VCIT, from its webpage .

First, I might note that, even though it shares with VGIT the word "intermediate" in its name, VCIT encompasses a modest percentage of corporate bonds with maturities of 10-15 years. This accounts for the slightly longer average duration of 6.2 years in VCIT, as opposed to 5.2 years in VGIT. So, a little more interest rate risk.

It is in the next screen, however, that we get to the key difference between the two ETFs.

Whereas VGIT is 100% U.S. treasuries, with their impeccable credit rating, almost 95% of VCIT carries a credit rating of either AA or BBB. While these are both investment-grade ratings, clearly there is a significant difference in credit quality. In fact, BBB is the lowest rating before a bond falls into the what is commonly referred to as the "junk bond" category.

In short, then, if one selects VCIT over VGIT, one is rewarded with roughly an additional 1% in current income, but at the "cost" of slightly higher interest rate risk and a fair amount of additional credit risk.

Let's now move on to our second alternative. Here's the portfolio composition of VGLT, from its webpage .

Here, the comparison to VGIT is even more straightforward. In both cases, the credit quality is the same, as both are composed of 100% U.S. treasuries. However, the interest-rate risk increases dramatically, due to VGLT's average duration of 16.1 years. Whereas the individual bonds in VGIT had maturities of between 3-10 years, VGLT for all practical purposes starts at 15 years, and roughly 64% of its holdings have maturities of over 20 years.

In terms of the respective price volatility of the 3 ETFs, I was able to pull up this very nice comparison from Seeking Alpha.

As can clearly be seen, VGIT features the lowest price volatility of the three ETFs, with VCIT coming in with slightly higher price volatility and VGLT presenting a significantly higher level due to its longer overall duration.

Summary and Conclusion

It's an interesting comparison, isn't it?

All three are Vanguard ETFs, with matching expense ratios of .04%. Any of the three ETFs is an excellent choice, depending on your personal risk tolerance and investment outlook.

VGIT offers in my mind perhaps the most compelling risk/reward balance at the present time, hence the reason I selected it as the featured ETF for this article.

For investors with a desire for a higher level of current income, and who can tolerate a little more risk, the other two ETFs offer intriguing options. At this particular time, I would probably go with VCIT if forced to make a choice. Of the three, VCIT offers the highest level of current income with only modestly higher price volatility.

What do you think? Please share your views in the comments section below.

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