Despite Big Losses, Investors Flock to Long-Term Bond ETFs

The iShares 20+ Year Treasury ETF TLT is down nearly 15% this year, but the exchange-traded fund’s poor performance hasn’t deterred investors.

Instead, the high yields brought on by the bond market’s sell-off seem to have attracted them. Investors have poured $17.2 billion into the $40.7 billion fund this year, making it the third most popular ETF in terms of flows so far in 2023.

In July, TLT recorded more than $4.7 billion of new money—its best month since it was launched in 2002. Following July’s record inflow, investors on net pulled money out of the fund in August, but they returned in September amid a continued bond market sell-off.

Investors may want to lock in long-term yields by investing in a fund that buys long-term Treasury bonds, according to Morningstar analyst Ryan Jackson.

Others may be using the fund as a hedge to risker assets, like stocks, says senior manager research analyst Paul Olmsted. But he warns that some investors may not fully comprehend the risks they are taking.

“Investors may think a U.S. Treasury bond is somewhat benign, but that’s far from the case,” Olmsted explains. No matter the issuer, long-term bonds are more sensitive to changes in interest rates than intermediate- or short-term bonds, and therefore are often more volatile.

What Is the iShares 20+ Year Treasury ETF?

The passively managed ETF invests in U.S. Treasury bonds that mature in 20 years or more.

The fund currently offers an SEC yield of 4.9%. (SEC yield represents what investors can expect to earn from a fund over the next 12 months based on what the fund has yielded over the previous 30 days.) That’s up from the 3.7% the fund offered a year ago.

However, thanks to the inverted yield curve—wherein short-term bonds offer higher yields than longer-term ones—there are other higher-yielding options. For example, the $16.5 billion iShares 0-3 Month Treasury Bond ETF SGOV offers an SEC yield of 5.3%.

Though short-term funds currently offer higher rates, when interest rates fall, their investor payouts will decrease more quickly while long-bond payouts stay elevated.

“Investors may be buying the fund with the expectation that long-term yields will eventually fall, especially if recessionary risks persist,” says Olmsted. “In a recession, inflation expectations fall, and long yields tend to follow.”

If the opposite occurs and interest rates go higher, long-term bond investors will be hurt, as they are locked into bonds that pay lesser rates compared with new bonds.

Persistent Inflows

Investors have flocked to the fund since the Federal Reserve started raising interest rates last March. During 2022, investors poured $15.3 billion into the iShares 20+ Year Treasury ETF, which made it the most popular bond ETF that year. Despite the fund’s 30% drop, its assets grew by 77% last year from inflows alone.

Since then, inflows have been persistent, with the exception of August, which snapped a 13-month streak. In September, amid another bond market sell-off that saw the fund lose nearly 8%, it gathered $1.5 billion.

TLT’s Record Losses

The funds’ inflows are even more remarkable in light of its poor performance. As the United States avoids a recession and inflation proves harder to bring down than expected, interest rates continue to march higher. This has brought large losses to long-term government funds.

Last year, the iShares 20+Year Treasury ETF fell 31.4%—its worst annual performance on record. This comes on the back of the fund’s 4.8% fall in 2021. Prior to 2022, the fund had never experienced two consecutive years of declines. With the fund now down almost 15% year-to-date, it’s on track to record its third straight year of returns. This means the majority of investors have yet to see positive returns.

Risks of Investing In Long Government Bonds

Olmsted warns that long-duration funds are “not for the faint of heart,” and points out that TLT’s primary risk is duration. This is a measure of interest rate sensitivity that takes into account bonds’ maturity and coupon rate. TLT’s 17-year duration means that for every 1% change in yields, the fund’s price changes by 17%.

This makes long-term bonds riskier than core bonds or even high-yield bonds. That can be seen in its standard deviation, which measures how much its returns can vary. The fund has a five-year standard deviation of 15.2%, higher than the iShares Core US Aggregate Bond ETF’s AGG standard deviation of 5.6% and iShares iBoxx $ High Yield Corporate Bond ETF’s HYG 9.2%. Instead, Olmsted says iShares 20+ Year Treasury ETF’s volatility is closer to that of the S&P 500′s.

If investors are looking at taking this risk, Olmsted says they should size the trade appropriately against their overall asset allocation and be able to withstand wide price swings.

Other Long Government Funds

While the iShares 20+Year Treasury ETF has attracted the most attention, the trend is broader. The $11.4 billion Vanguard Long-Term Treasury Index Fund VLGSX has collected $4.2 billion this year, and the $18.6 billion Fidelity Series Long-Term Treasury Bond Index FTLTX has gathered $2 billion.

“iShares has emerged as a go-to provider for Treasury ETFs, so it makes sense to see one of their offerings establishing itself as the most popular long government fund,” says Jackson.

The $28.5 billion iShares 7-10 Year Treasury Bond ETF IEF, which also falls in the long-term category, collected $6.2 billion this year.