ETF Of The Week: Yield Curve’s Sweet Spot?

In the bond market, there's a handy rule of thumb: When interest rates are rising, you want to be in short-term bonds; when rates are falling, you want to be in long-term bonds.

However, if you don't know what the heck will happen with rates, intermediate-term bonds can offer a best-of-both-worlds sweet spot, as they offer better yields than shorter-term, with less interest rate risk than longer-term.

We're seeing that play out now in the U.S. Treasuries space, where the SPDR Bloomberg Barclays Intermediate Term Treasury ETF (ITE) has pulled in $809 million in new net inflows over the past 30 days. As a result, ITE's assets under management have grown by 140%, or more than any other ETF we track.

A Single Day Of Good Flows

Most of that new money came in at once. On Jan. 3, $719 million flowed into ITE in trading.

That's especially notable because ITE remains a comparatively small fund. It only has $1.5 billion in assets under management, as compared to the largest fund in the space, the $12.2 billion iShares 7-10 Year Treasury Bond ETF (IEF).

ITE provides pure exposure to the intermediate portion of the Treasury curve, tracking the Bloomberg Barclays U.S. 3-10 Year Treasury Bond Index, a market-weighted benchmark of U.S. Treasuries with remaining maturities between three and 10 years.

However, ITE isn't the only fund to track this benchmark. It competes with the $3.6 billion Schwab Intermediate-Term U.S. Treasury ETF (SCHR) and the $3.5 billion Vanguard Intermediate-Term Treasury Index ETF (VGIT).

Cost Isn't Everything

Not only is ITE smaller than its competition, it's also more expensive. Whereas ITE costs 0.10% in annual expense ratio, SCHR costs 0.06%, while VGIT costs 0.07%.

Yet both those funds saw fewer net inflows over the past month than ITE. SCHR brought in $461 million, while VGIT brought in $261 million.

There's any number of explanations as to why this might be, and without knowing who purchased ITE on Jan. 3, we'll never know the why. But the reason may have something to do with interest rate risk.

A bond fund's sensitivity to interest rates is measured by its duration: The higher a duration, the more impact that rate hikes or drops can have on its portfolio (read: "Understanding Duration").

Of the three funds, ITE has the lowest duration, at 3.78, whereas SCHR and VGIT have higher durations of 5.09 and 5.11, respectively. (ITE achieves that duration by concentrating its portfolio in three- to five- year Treasuries.)

‘Patient’ Fed

Knowing that, investors' preference for ITE makes a lot of sense. In the month since the last rate hike, Fed Chairman Jerome Powell has changed his tune, now saying the Fed plans to be "patient" as it weighs future rate increases for 2019.

What that means is anybody's guess, but at least some investors seem to be assuming rate hikes are still on the horizon. As such, they've shifted their intermediate-term Treasury exposure toward the shorter term to reduce their downside potential if and when rates rise.

Over the past month, ITE has returned 0.97%.

Contact Lara Crigger at [email protected]