Don't Be SHY: Embrace This Bond ETF

Investors have been feasting on U.S. government bond exchange traded funds this year. One of the recipients of that largess is the iShares 1-3 Year Treasury Bond ETF SHY.

As global equity markets have seen increased turbulence to start 2016, investors have been running to safe-haven destinations. That includes exchange-traded funds holding U.S. government bonds. Professional investors are expected to boost their usage of fixed-income ETFs with nearly two-thirds already owning bond ETFs, according to a recent Greenwich Associates study.

SHY's 30-day SEC yield of 0.72 percent is not awe-inspiring, but it's better than being involved with other negligible or negative rate fare found throughout the developed world and it is certainly better than the yield investors will find on most cash instruments. SHY turns 14 in July and its current yield is low relative to historical norms.

“By historical standards, however, the fund's current yield is still relatively low. Over the decade ended March 2016, the two-year Treasury yield traded as low as 0.16% (September 2011) and as high as 5.3% (June 2006), and it averaged 1.3% over the entire period. With yields still near the low end of that range as of the beginning of April, there's little room for  price appreciation,” said Morningstar in a recent note.

The allure of an ETF like SHY is not so much its yield, though investors can do worse elsewhere. Rather, SHY's allure is derived being a safe-haven option even if interest rates rise. SHY's credit quality is not an issue and its effective duration of just 1.85 years ensures the ETF can endure a spate of interest rate hikes, should such a scenario come to pass. That is assuming the Fed does not consistently raise short-term rates. If that happens, SHY would lose its luster.

“The Federal Reserve has indicated that it expects to continue to raise rates, albeit at a gradual pace with any increases dependent on economic data, including the unemployment rate and inflation. The Federal Open Market Committee members’ estimates of the long-run rate of normal unemployment range between 4.7% and 5.8%; the unemployment rate of 5.0% as of March 2016 was at the low end of that range. However, core personal consumption expenditure inflation continues to run under the Federal Reserve’s 2% stated target,” adds Morningstar.

SHY charges just 0.15 percent per year, or $15 for every $10,000 invested.