2023-04-19 13:53:19 ET
Summary
- UTWO is about as easy to understand as any ETF. Or is it? On the surface, it just buys the 2-year US Treasury Note. That's it.
- However, as opposed to buying and holding that bond until it matures in 2 years, UTWO swaps out its holding whenever a new 2-year bond is issued.
- Given the unique moment in history for the bond market, I find this ETF to be a potentially opportunistic tool for contemporary income investors.
I am a huge believer in this: when it comes to investing in complex, modern markets, the vast majority of investment firms make things more difficult than they need to be. This is a time when investors should focus on 2 things:
1. How to incorporate a brand-new style of bond investing into their portfolios. This is especially critical if income is a priority, but nearly as vital to understand if it is not. The bond market, or at least at this point the US Treasury securities market, offers an array of tactical and intermediate-term strategies that for 15 years were dormant. That's because interest rates were close to nil, and so a big part of bonds' appeal to investors other than pro bond traders was close to nil as well.
2. How to do all they can to prevent succumbing to "tail risk." That's the risk of exogenous events that are likely not anticipated by the market turning retirement plans to dust. We saw this twice before during this century (2000-2003 and 2007-2009) and while we may not see it again, I cannot emphasize enough that current conditions make this a compelling time to guard against tail risk. How one does that is a personal choice. For some [[UTWO]] may play a role.
UTWO: what is this thing?
This ETF is part of a series of similarly-structured set of funds (with a range of maturity dates) launched in 2022, known as the "US Benchmark Series." It owns a single security: the current "on the run" 2-year US Treasury Note. On the run means that it is the most recent 2-year T-Note issued by the US Government. Since 2-year Notes are issued monthly, that means that UTWO owns a bond for about a month, then trades it in for the newest 2-year Note.
While some might question why this strategy would be useful, consider the last 16 months in the bond market. Yields on short-term securities went from very little to the highest rates in years. The purchase of a 2-year US Treasury Note a year ago would have paid very little interest versus today. And, while interest rate risk is present, when it involves such a short-term part of the Treasury yield curve, that risk of a major price change is low. In fact, we may just see the worst of it, given how quickly rates ratcheted up last year and early in 2023.
Why not just own the 2-year and hold it?
Clearly, that is an option available to any investor, any time, through Treasury.gov or a brokerage firm online or otherwise. However, with more than $300mm in AUM, UTWO should be expected to get very tight pricing, keep expenses low, and do the work each month to be sure that the current 2-year is always the one security sitting inside this ETF. So far, so good.
UTWO also pays a monthly dividend, whereas a buy and hold 2-year note owner only receives income payments every 6 months. This ETF is one of a growing list of monthly dividend payers I am tracking, as it appears the ETF industry is responding to the massive interest in monthly income from Baby Boomers (like me) with innovative securities like this one.
And, I find that as a tactical manager, and with a bond market whose prices and yields are flopping around in ways we don't often see, I like the idea of having the convenience of UTWO. Indeed, while the return earned by holding a single 2-year US Treasury for its full 24-month life (i.e. buying it on the run, then holding it through its 23 months of "off the run" status), an investor's cash income yield is fixed. Since I think the Fed is not done raising rates, nor is the bond market done lifting short-term rates independent of the Fed, I like having UTWO as a tool in my proverbial income tool box.
As with any investment analysis or portfolio decision I make, I try to consider as many possible outcomes as possible. Here are a few I consider when looking at how to respond to what you see in the chart above, which is 45 years worth of history on the rate of 2-year US Treasury Notes.
1. If rates stay around this level for a while, I lock in a yield in the low 4% range, and it won't float around much. 2 years is like an eternity in investment time nowadays, and having a portion of my retirement portfolio positioned there is part of a wider plan to wait out the current storm raging in the longer-term end of the bond market, in the market for "credit" (non-Treasury) bonds, and the indecision in global equity markets.
2. If rates reverse recent trends and fall, UTWO should produce a decent total return. While the chart below is not exactly a lengthy testing period, I'll note that when rates dropped suddenly in March, UTWO edged out the 1-3 Year Treasury Bond iShares ETF ( SHY ), which until UTWO came along, was my default option for investing in this part of the yield curve. It is a short "stress test" but UTWO's structure did not cost investors one bit. It gained over 2% in a matter of days, just as SHY did.
3. If the 2-year US Treasury rate continues higher, I keep getting more yield. Sure, there will be some price slippage, but using SHY as a proxy, here is a chart of 1-year rolling total returns for this part of the yield curve going back nearly 20 years. It took a historic, shocking degree of Fed rate hikes and bond market price selloff to cause this part of the yield curve to produce a negative return. While I can see real potential for rates to go much higher in time (the technician in me sees a dangerous long-term breakout in yields looming in the first chart above), inflation and rising rates are not taking the bond market by surprise the second time around. Thus, I suspect any possible move higher in rates will be less spirited, and more of a grind higher, perhaps over several years. In that environment, UTWO's monthly roll feature will be able to adjust and produce a return stream more like a floating rate bond.
UTWO: a targeted, timely ETF - and the crowd likes it
UTWO's assets under management have climbed steadily since its August 2022 debut, and now stand at over $330mm.
Furthermore, average trading volume is now around $8mm a day. UTWO is straightforward, it pays that monthly dividend, I know exactly what I own, and I'm willing to trade in a few basis points for the convenience of buying and selling UTWO exactly when I want to, via an ETF. I rate UTWO a Buy, particularly as a larger part of building a Treasury income fortress section of my broader income portfolio.
For further details see:
UTWO: I Will Follow This New 2-Year Treasury ETF Closely