SHY's Double Play of Yield and Price Appreciation

If there was ever a case of past performance not being an indicator of future returns, it could be short-term bond ETFs. The iShares 1-3 Year Treasury Bond ETF (SHY) is one of the largest in its category, even though it has lived up to its ticker symbol for a long, long time. 

Over the past 15 years, it appeared to be shy about making much of a return for investors. SHY’s annualized total return during that period was a mere 0.9%. That is a direct result of an ultra-loose monetary policy, in which the Federal Reserve kept short-term interest rates near zero for a very long time. 

But that was then, and this is 2023. SHY and other exchange-traded funds that target the part of the yield curve just beyond T-bills are a potential sweet spot for investors in the months ahead. Their yields rival those of other parts of the U.S. Treasury market, as the one-year note yields 5.4% and the three-year note yields 4.9%. 

To get those yields, however, the price risk is just a fraction of what investors take on at the popular 10–30-year end of the bond market. Treasury bill rates are still higher than anything else, but a sudden decline in rates could erase that edge quickly.  

Short-term Treasury ETF 

Short-term Treasury notes may be one of the last things investors think about when it comes to profit opportunities. The selling point for ETFs like SHY and its peers is a relatively stable price, and more recently, some very attractive yields. But there are some significant, albeit rare, scenarios in which SHY and its ilk can deliver a true investment “double play” to investors, where capital appreciation adds to the robust yield. 

SHY made its debut way back in 2002, and so its track record contains a lot of history we can learn from. Particularly when markets get panicky and short-term rates drop in a “flight to safety,” funds like SHY have had some surprisingly strong profits, unrelated to what they were yielding at the time.  

SHY's History

For example, from mid-July 2007 through mid-March 2008, the start of the global financial crisis, SHY gained 5.65% during those eight months, from price appreciation alone. Just over a decade later, from the start of November 2018 through the end of April 2020, a period that included S&P 500 declines of 20% and 33%, SHY’s price-only return was 4.60%.  

SHY has one disadvantage for income-focused investors. The historically fast rise in short-term rates means that of its 86 holdings, many have very low coupon rates from back when they were issued, when the Fed’s zero interest rate policy was fading out. The fund’s average coupon is just 2.6%, despite a 5.1% yield to maturity on its portfolio. 

Income Yields 

The price part of bond return math is consistent over time. What changes over time is the income yield the bonds pay. And, as all investors now know, those fixed rates are higher than they have been in about a decade and a half. 

So, the prospect of earning a yield around 5% plus potential to add some return during the most volatile times for the stock market could get this SHY ETF out of the shadows. And in a market starved for profitably ideas since the beginning of last year, the potential of the often-overlooked short-term Treasury ETF sector may be worth a closer look.