Balance a Stock-Heavy Portfolio With This ETF

U.S. Treasury bonds can serve as a ballast for your portfolio during turbulent markets because they offer diversification benefits. The total returns of Treasury bonds are negatively correlated with the U.S. stock market. These low-risk securities are also backed by the United States government, so they carry minuscule credit risk, or the risk that the lender won’t make good on coupon payments. iShares US Treasury Bond ETF GOVT is a compelling option for exposure to U.S. Treasuries across the entire yield curve. This low-cost strategy earns a Morningstar Analyst Rating of Bronze.

This strategy tracks the ICE U.S. Treasury Core Bond Index, which holds Treasury bonds with one to 30 years remaining until maturity and weights them by market value. Most active Treasury bond managers derive most of their active returns from yield-curve positioning. That said, U.S. Treasuries are one of the most competitively priced areas of the bond market, so indexing Treasuries is a solid approach because it is difficult for active managers to recoup their fees.

This portfolio tends to take greater interest-rate risk than most of its peers. As of this writing, the strategy’s duration measured 0.7 years longer than the average fund in the intermediate government Morningstar Category. But the strategy is compensated for this higher interest-rate risk with higher return potential. The shape of the yield curve can influence the attractiveness of this trade-off. The steeper the yield curve is, the better investors are compensated for the interest-rate risk. The duration risk of this strategy changes with bond-issuing activity. Since its inception in February 2012, this fund’s duration has crept up by 0.8 years.

Interest-rate risk drives U.S. Treasury returns because these bonds have minimal credit risk. This strategy’s slightly longer duration profile compared with the average fund in the category has generated returns that line up with performance expectations. It has outpaced the category average by 11 basis point annually from its inception in February 2012 through February 2019 with higher risk.

Fundamental View Treasury bonds fund federal government operations. These bonds have virtually no default risk because the government can collect taxes to repay the debt. Accordingly, Treasuries offer lower yields than other bonds, such as those issued by corporations. Interest income on Treasury securities is tax-exempt at the state and local levels, which improves their aftertax yield.

The strategy has greater exposure to rate movements than most of its intermediate-government category peers because it tends to own longer maturity bonds. The portfolio’s interest-rate risk has crept up over the past few years. Since 2009, the Treasury Department has been issuing longer-term Treasury bonds to address long-term Medicare- and Social Security-related expenses, while taking advantage of low interest rates.

This fund offers good downside protection and can serve as a portfolio ballast during market turmoil. When markets go through a period of stress, Treasuries attract demand because of their perceived safety. This strategy launched in February 2012, but its index posted a cumulative gain of 13.4 percentage points from November 2007 through February 2009, while the S&P 500 lost 50.9 percentage points. But when the S&P 500 rebounded between March and December 2009, this fund’s index lost 0.1 percentage points.

The strategy’s annual return topped that of the category by 0.1 percentage points annually from February 2012 through February 2019. This was partially because it took a little more interest-rate risk than most of its peers, which paid off over this horizon. However, that also made it a little risker than the category average.

Portfolio Construction The fund earns a Positive Process rating because it accurately captures the broad U.S. Treasury market at a low cost. Its market-value-weighting approach reduces transaction costs by leaning toward the largest and most liquid securities.

The managers employ representative sampling to track the ICE US Treasury Core Bond Index, which measures the performance of the U.S. Treasuries that have between one and 30 years until maturity. The index includes U.S. Treasury securities that have $300 million or more of outstanding face value, excluding amounts held by the Federal Reserve. In addition, qualifying securities must be fixed-rate and denominated in U.S. dollars. The index excludes inflation-linked securities, Treasury bills, cash management bills, any government agency debt issued with or without a government guarantee, and zero-coupon issues that have been stripped from coupon-paying bonds. The index is weighted by market value, and the securities are updated on the last business day of each month.

Fees BlackRock charges a low fee of 0.15% for this fund, which offers a durable advantage and supports its Positive Price Pillar rating. This is considerably lower than the median category fee of 0.50%. During the past year through February 2019, the fund lagged its benchmark by 11 basis points.

Alternatives Investors seeking more targeted exposure to portions of the U.S. Treasury curve in the intermediate government Morningstar Category have several strong options. Silver-rated Vanguard Intermediate-Term Treasury ETF VGIT (expense ratio 0.07%) is one of the lowest-cost options in the intermediate government category, making this option more attractive. The fund replicates the Bloomberg Barclays U.S. 3-10 Year Government Float Adjusted Index and invests in Treasury securities with a maturity between three and 10 years. Its duration is slightly shorter than that of GOVT.

IShares offers a suite of Treasury funds that target different duration segments of the yield curve. Each of these funds earns a Morningstar Analyst Rating of Bronze and carries a fee of 0.15%. In the intermediate government category, this includes iShares 1-3 Year Treasury Bond ETF SHY and iShares 3-7 Year Treasury Bond ETF IEI. IShares also offers several funds in the long government category. These include iShares 7-10 Year Treasury Bond ETF IEF, and iShares 10-20 Year Treasury Bond ETF TLH, and iShares 20+ Year Treasury Bond ETF TLT.

Vanguard Long-Term Treasury ETF VGLT (expense ratio 0.07%) is one of the lowest-cost options in the long-government category. The fund replicates the Bloomberg Barclays US Long Treasury Bond Index and invests in Treasury securities with more than 10 years until maturity. This increases its duration compared with GOVT, so VGLT is more sensitive to interest-rate movements.

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