Gaul: Roll Down The Curve With BSCI

March 21, 2014

Playing the steepness of the yield curve isn't only sensible, it's totally doable with ETFs, Boston Advisors' James Gaul says.

This article is part of a regular series of thought-leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features James Gaul, vice president and portfolio manager for Boston-based Boston Advisors LLC.

In today’s low-yield environment, fixed-income investors are focused on identifying investment strategies that seek to maximize yield, while positioning against rising interest rates.

However, the current rate environment—or more specifically, the yield curve—has a notable characteristic that is often overlooked: It is very steep.

In fact, over the last 30 years, the spread (or difference) between the 10-year Treasury and two-year Treasury has only reached the current 235 basis points on four other occasions—in 1992; in 2004; in 2010; and in 2011. During each of these time periods, the economy was enjoying the early stages of an economic recovery.

Such a steep yield curve provides investors with an opportunity to generate attractive total returns via a “roll down” strategy. Even better, a suite of term-maturity ETFs now exists that allows ETF investors to implement this strategy in a cost-efficient manner.

10_Year_2_Year_Spread

A roll-down strategy works when a steep curve produces a year-over-year drop in yield significant enough to cause bond prices to increase simply by moving one year closer to maturity. To illustrate, a Treasury bond maturing in five years carries a yield to maturity of 1.60 percent. In the current rate environment, and assuming a stable yield curve, the yield on the bond will fall to 1.20 percent simply by moving the calendar forward one year. The result will be a higher price and a positive total return.

Treasury_Curve_Chart

 

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