ETF Of The Week: Tale Of 2 Bond Funds

iShares' 'SHY' and 'SHV' a microcosm of investors' Fed expectations.

All month, investors were busy rejiggering their portfolios in advance of Wednesday's meeting of the Federal Reserve. Market observers widely expected that, at the meeting, the Fed would leave its benchmark interest rate unchanged, while setting the scene for a possible rate cut in July (which is exactly what it did).

As a result, the iShares 1-3 Year Treasury Bond ETF (SHY) saw a staggering $2.2 billion of net outflows, while the iShares Short Treasury Bond ETF (SHV) has brought in new assets of $4.0 billion over the same time period:

Source: ETF.com; data as of June 19, 2019

Those were by far the biggest flows in and out of any bond ETF this month. In fact, SHY's outflows have topped the list of ETF redemptions so far in June.

To SHV From SHY & Back Again

Though both SHV and SHY are short-term Treasury bond ETFs, the difference is in precisely how short term they really are. SHY holds Treasuries with 1-3 years left until maturity, while SHV holds Treasuries with less than 12 months remaining.

Flowswise, that time horizon has made all the difference. Investors who believe a rate cut is in the imminent future are more likely to shift their fixed income allocation toward shorter maturities.

Interest rates and bond prices are inversely related; meaning that when interest rates drop, bond prices tend to rise. That's because bonds issued after the rate cut will yield less than older ones, making them less attractive for investors seeking income.

That is why investors are moving their money toward the shorter-term SHV and away from SHY. It's an easy trade to make: Both funds are equally priced, with an expense ratio of 0.15%, and they both have massive liquidity, with tight spreads of 0.01% and over $250 million in volume traded daily each.

Future Rate Cuts Ahead

The Fed's decision on Wednesday largely met expectation. Though the agency held off on an interest rate cut at present and denied further cuts for the rest of the year, it suggested that one or two rate cuts might still happen sometime next year.

Given that time frame, it'll be interesting to see if investor money shifts out of SHV and back toward SHY, or if investors are willing to be as "patient" as the Fed claimed it plans to be.

Contact Lara Crigger at [email protected]