Long-Term Bond ETFs: Stellar Returns In Chaotic Environment

by on October 27, 2011 | ETFs Mentioned:

With the fourth quarter of 2011 now well underway, the year is generally shaping up to be one that many investors will try quickly to forget. After 2009 and 2010 brought steady recoveries from the chaotic downturn in 2008, this year has seen renewed concerns about mounting debt burdens around the globe and slowing growth in both developing and advanced economies [see also Build America Bond ETFs: Crushing The Muni Competition].

Just about every corner of the global equity market is drenched in red; few stocks have managed to climb higher in 2011 amidst a spike in risk aversion and a general flight away from equities. Even those on relatively stable fiscal footing have been battered, tumbling on fears that weakness elsewhere in the world will drag down all markets.

It is, of course, not uncommon for fixed income securities to perform relatively well during tumultuous times. When stocks encounter turbulence, investors often flock towards the relative safety of bonds, snapping up fixed income securities that deliver relatively predictable yields and coupon payments. Bonds–especially those issued by the U.S. government–are generally expected to exhibit stable returns with low volatility [see also Hedge Market Exposure With These Innovative ETNs].

But in 2011, some bond ETFs have been an unexpected–and no doubt welcome–source staggering returns for investors who were unafraid to take on some significant duration risk. So much for slow, steady gains; several long-term bond ETFs have surged by 25% or more in 2011 as investors have flocked towards this asset class [for more ETF ideas, sign up for the free ETF newsletter]:

  • Vanguard Extended Duration Treasury ETF (EDV): This ETF is linked to the Barclays Capital U.S. Treasury STRIPS 20-30 Year Equal Par Bond Index, an index that consists of long-dated STRIPS–single coupon or principal payments on Treasuries that have been segmented into separately traded components. EDV pays out a decent distribution yield between 3% and 4%, but this fund’s gains so far in 2011 are considerably greater than just the current return; through the first three quarters of the year, EDV was the best performing non-leveraged ETF, adding more than 50% through September.

  • PIMCO 25 Year Zero Coupon U.S. Treasury Index (ZROZ): This ETF tracks the BofA Merrill Lynch Long Treasury Principal STRIPS Index, an unmanaged index that  is comprised of securities representing the final principal payments of U.S. Treasury bonds with a minimum of $1 billion in outstanding face value and a weighted average maturity of approximately 28 years. ZROZ  has an impressive SEC 30-day yield of about 3.2%  and has gained about 40% year-to-date.
  • U.S. Treasury Long Bond Bull ETN (DLBL): This ETN is linked to the Barclays Capital Long Bond U.S. Treasury Futures Targeted Exposure Index, which seeks to produce returns that track movements in response to a change in the yields available to investors purchasing long dated U.S. Treasury bonds. Like other ETNs, DLBL has the advantage of being a relatively safe product that has no tracking error. Although DLBL has gained over 30% year-to-date, it is important to note its relatively high expense ratio of 0.75%.

In what can only be described as a tumultuous environment,  2011 has shown that some bond ETFs are in fact capable of generating significant returns in a relatively short period of time. Of course it should be noted that bonds with lengthy durations are capable of big moves to the downside if interest rates climb; there is no guarantee that any of these funds will hang on to the impressive gains throughout the end of the year (some have given back significant ground already). For those who have rushed to exit the hammered global equity markets this year, perhaps taking a second look at the traditionally-viewed ‘safe haven’ bond ETFs can provide some interesting opportunitites [see also WisdomTree Rolls Out Australian Bond ETF (AUNZ)].

Disclosure: No positions at time of writing.