The past three years have been tough for fixed income investors. Rapidly increasing interest rates and stickier-than-anticipated inflation created a volatile return environment—an unwelcome surprise in an asset class that most investors expect to serve as the “boring” part of their portfolio.
The silver lining of this volatility? Fixed income securities finally offer meaningful yields. That’s a big change from the near-zero yields bonds have offered over the past decade. Despite higher yields, the negative return environment of 2021 and 2022 remains top of mind for many advisors: They remain cautious about allocating their clients’ portfolios back to bonds.
Cash may not be king
If you’ve been keeping cash on the sidelines since 2022’s extreme tumult in the fixed income market, you’re not alone. Money market assets under management are at an all-time high relative to the past 30 years. But today’s high yields and a shifting focus for the Federal Reserve may change the equation.
Higher starting yields on bonds can help provide your clients with a larger cushion against future price declines if rates increase. And while cash pays a high yield today, rate cuts expected in the year ahead suggest that high yields may not be here for long. Treasury bonds may give your clients a way to get back into the fixed income market. They can lock in higher yields for longer while introducing a ballast against an equity downturn in their portfolio.
Why Treasuries offer better value now
Bond investors likely saw yields rise to their highest point last fall. The yield on the 10-year U.S. Treasury note began 2023 at 3.34%. It rose to 5% in mid-October before falling back to under 4% by year-end. The market has begun to focus on determining the frequency and pace of rate cuts in the years ahead. That means you have an opportunity to lock in higher-than-average Treasury yields and protect your clients’ portfolios now. In our fixed income outlook for the first quarter of 2024, we estimate rates will ultimately settle above the levels we saw after the 2008 global financial crisis, which were unusually low. Yields across fixed income markets have increased and credit spreads across sectors are tight, offering investors less additional return over nominal returns. With this backdrop, Treasury bonds can provide your clients with some protection during a bear market flight to safety, without sacrificing a high amount of yield. We find that even when advisors have maintained their fixed income exposure, their portfolios are often underweight in Treasuries. In 2023, nearly 70% of advisor portfolios underweighted Treasuries compared with the Bloomberg U.S. Universal Index, according to an analysis of 1,178 fixed income portfolios by Vanguard Advisor Portfolio Analytics and Consulting.
Chart1
A series of bar-and-dot charts showing December 2023 returns, trailing 1-year returns as of December 31, 2023, and yields to worst as of December 31, 2023, for several taxable fixed income sectors.
Emerging markets bonds had a December return of 4.7%, a trailing 1-year return of 11.1%, and yield to worst of 7.8%; U.S. corporate bonds had a December return of 4.3%, trailing 1-year return of 8.5%, and yield to worst of 5.1%; U.S. mortgage-backed securities had a December return of 4.3%, trailing 1-year return of 5.1%, and yield to worst of 4.7%; global aggregate bonds had a December return of 4.2%, trailing 1-year return of 5.7%, and yield to worst of 3.5%; U.S. aggregate bonds had a December return of 3.8%, trailing 1-year return of 5.5%, and yield to worst of 4.5%; U.S. high-yield bonds had a December return of 3.7%, a trailing 1-year return of 13.4%, and yield to worst of 7.6%; U.S. Treasuries had a December return of 3.4%, trailing 1-year return of 4.1%, and yield to worst of 4.1%; U.S. commercial mortgage-backed securities had a December return of 3.0%, trailing 1-year return of 5.4%, and yield to worst of 5.3%; Treasury Inflation-Protected Securities had a December return of 2.7%, trailing 1-year return of 3.9%, and yield to worst of 4.2%; municipal bonds had a December return of 2.3%, trailing 1-year return of 6.4%, and yield to worst of 3.2; U.S. asset-backed securities had a December return of 1.9%, trailing 1-year return of 5.5%, and yield to worst of 5.0%
Notes: The municipal tax-equivalent yield is calculated using a 40.8% tax bracket, which includes a 37.0% top federal marginal income tax rate and the 3.8% Net Investment Income Tax to fund Medicare.
Sources: Bloomberg indexes and JP Morgan EMBI Global Diversified Index, as of December 31, 2023.
Past performance is no guarantee of future returns. The performance of an index isn't an exact representation of any particular investment, as you can't invest directly in an index.
Cover the Treasury spectrum with just four low-cost Vanguard ETFs?
We designed our Treasury ETF lineup with four funds as building blocks so that you can construct efficient, straightforward, low-cost portfolios.
With this suite of Vanguard U.S. Treasury ETFs, you can tailor portfolios to individual clients and accomplish a wide range of goals:
Provide investors with liquid exposure to the full range of Treasury bonds.
Target the duration and maturity profiles of your clients' fixed income sleeve.
Incorporate tilts that may be able to help shelter clients during equity downturns.
Decrease the overall credit risk of a portfolio while aligning to your clients' targeted duration.
Vanguard's approach, reputation, and scale confer significant benefits to you and your clients:
You and your clients gain greater coverage across most markets, efficient operations, and instant diversification with exposure to hundreds of securities because our portfolios hold many bonds on a relative basis.
You'll find our strong reputation with market participants provides best possible execution from bond dealers and participation in primary issuances.
You can maximize returns for your clients. Our deep and experienced team manages portfolios that minimize transaction costs and tracking differences relative to our benchmarks.
Get lower costs in more ways than one
You can always count on us to strive to help your clients keep more of their money in their pockets. Our suite of Treasury ETFs accomplishes this in two ways.
Cost advantage number one: Because our Treasury ETFs are so liquid, it’s less expensive to buy the ETF (in terms of bid-ask spread) than to buy the individual bonds. Our lower trading costs offset 50% to 100% of the ETF's expense ratio for your clients.
Bid-ask spreads of Vanguard Treasury ETFs compared with underlying bonds
Vanguard ETF
ETF bid-ask spread
Underlying securities' spread
ETF expense ratio
Short-Term Treasury ETF (VGSH)
2 basis points
4 basis points
4 basis points
Intermediate-Term Treasury (VGIT)
2 basis points
5 basis points
4 basis points
Long-Term Treasury (VGLT)
4 basis points
13 basis points
4 basis points
Extended Duration Treasury ETF (EDV)
9 basis points
41
6 basis points
Source: Bloomberg Finance LP as of January 31, 2024.
Note: Vanguard estimated the underlying bond bid-ask spread using Bond Liquidity Analysis, a proprietary calculation that uses Bloomberg data to estimate an aggregated bid-ask spread for the underlying portfolio of bonds for the 20 trading days ended January 31, 2024.
Cost advantage number two: Besides tight bid-ask spreads, Vanguard's expense ratios beat the industry average by a significant margin across maturities:
Expense ratios of Vanguard funds compared with the Lipper peer averages
Vanguard ETF
Fund expense ratio
Lipper peer average
Short-Term Treasury (VGSH)
4 basis points
33.1 basis points
Intermediate-Term Treasury (VGIT)
4 basis points
20.9 basis points
Long-Term Treasury (VGLT)
4 basis points
20.9 basis points
Extended Duration Treasury ETF (EDV)
6 basis points
20.9 basis points
Source: Lipper data as of December 31, 2022 .
What's the bottom line?
Markets are always unpredictable, but current Treasury yields look strong. Higher yields across fixed income markets historically have provided more of a cushion against negative returns. Given that many advisors underweighted Treasuries, you may want to consider adding to your allocations to lock in rates that are relatively high.
Notes:
For more information about Vanguard funds or Vanguard ETFs, contact your financial advisor to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information are contained in the prospectus; read and consider it carefully before investing.
Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.
Past performance is no guarantee of future results. All investing is subject to risk, including possible loss of principal. Diversification does not ensure a profit or protect against a loss.
Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.
U.S. government backing of Treasury or agency securities applies only to the underlying securities and does not prevent share-price fluctuations. Unlike stocks and bonds, U.S. Treasury bills are guaranteed as to the timely payment of principal and interest.
Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
