Long Term Bond Funds: High Risk, High Return
How would you like to own a bond fund that managed to return 55.9% in a single year? That’s what the Vanguard Extended Duration Treasury ETF (ticker:EDV) did in 2011 – a year that brought a sharp decline in U.S. Treasury yields. Better yet, how about a bond fund that gained 107.6% in the same year? Those were the results posted by the Direxion Daily 20+ Year Treasury Bull 3X Shares ETF (TMF), a leveraged ETF that uses futures to seek daily results three times the return of long-term Treasuries. Great results, to be sure – but investors need to be acutely aware that long-term bond funds also carry substantial risks.
From the return figures above, it’s clear that long-term bond funds can sometimes provide the type of gains that are typically associated with small-cap stocks. The reason for this is that when bond yields fall, longer-term issues generally provide the best performance. As a result, 2011 was the perfect environment for these funds: during the course of the year, the yield on the 10-year note plunged from 3.31% to 1.87% as its price rose.
Long-term bond funds can therefore be an excellent trading vehicle, but not necessarily the best investment. This is particularly true for bond investors, who are usually looking to collect income and minimize volatility. Unfortunately, these funds have volatility in spades. Take the one-week period from March 7 – March 14, 2012. During this time, investors sold U.S. Treasuries with reckless abandon in response to mounting evidence of improving economic growth. In this short interval, the two funds mentioned above – EDV and TMF – returned -7.18% and -14.60%, respectively. Most bond investors would consider such a return a bad year, but this meltdown took only a week. Be aware of the downside risks if you’re considering an investment in a long-term bond fund in general, and a leveraged fund in particular.Learn more: Are leveraged bond ETFs right for you?
The Implications of the Broader Rate Cycle for Long Term Bond Funds
Investors who are considering these funds need to think about the broader interest rate cycle. U.S. Treasury yields have been in a downtrends since 1982, and they are being pinned at very low levels by the ultra-low interest rate policy of the U.S. Federal Reserve. Any sign that economic growth is returning to a normal footing and/or that the Fed is preparing to boost rates, will likely send Treasury yields soaring higher. Again, this indicates that these funds may be a questionable long-term investment as long as rates are near their all-time lows.
ETFs that Invest in Long-Term Treasuries
Keeping in mind that many of these funds may be best used for trading, rather than as a core element of a diversified fixed-income portfolio, here is the broad range of options that invest in long-dated government bonds:
- iShares Lehman 20+ Year Treasury Bond Fund (TLT)
- Vanguard Extended Duration Treasury ETF (EDV)
- Long-Term Bond ETF (BLV)
- iShares 10+ Year Government/Credit Bond Fund (GLJ)
- SPDR Lehman Long Term Treasury ETF (TLO)
- iShares Lehman 10-20 Year Treasury Bond Fund (TLH)
- Long-Term Government Bond ETF (VGLT)
- PIMCO 25+ Year Zero Coupon U.S. Treasury Index Fund (ZROZ)
Leveraged ETFs that Magnify the Returns of Long-Term Treasuries
- Direxion 10-Year Treasury Bull 3X - Triple-Leveraged ETF (TYD)
- Direxion 30-Year Treasury Bull 3X - Triple-Leveraged ETF (TMF)
- iPath US Treasury 10-year Bull ETN (DTYL)
- PowerShares DB 3x Long 25+ Year Treasury Bond ETN (LBND)
- iPath US Treasury Long Bond Bull ETN (DLBL)
- ProShares Ultra 20+ Year Treasury ETF (UBT)
- ProShares Ultra 7-10 Year Treasury ETF (UST)
Disclaimer: The information on this site is provided for discussion purposes only, and should not be construed as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.