VGSH: Reviewing A Cash Parking Vehicle

seekingalpha2023-11-21

Vanguard Short-Term Treasury ETF holds Treasury Bonds maturing in 1-3 years.The duration risk is low and the yield is on the rise.We review the fund in light of the multiple rate cuts expected over ...

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ZolakiShares 1-3 Year Treasury Bond ETF (SHY) holds a portfolio comprising Treasury Bonds maturing between 1-3 years. The Vanguard Short-Term Treasury ETF (NASDAQ:VGSH) also does the same, which explains the proximity of their price and total return movements over the years. Data by YChartsAfter a long hiatus, interest rates started showing signs of life in 2022 and investors renewed their interest in funds which could serve as cash parking vehicles. We had covered SHY a few times in the 2020-2022 time frame, so we took a look at its doppelganger VGSH around September of last year. While a review of the fund did not convince us to become a buyer, we agreed that the fund would not be a bad investment for individuals that fit the VGSH profile. Such funds are appropriate for the short-term reserves portion of a long-term investment portfolio, for investors with short-term investment horizons (no longer than three years), and for investors whose tolerance for share-price fluctuations is very low or whose employment or financial situation is precarious. Source: VGSH - Vanguard While the fund lagged some of the other funds that were not bogged down by duration risk, like the US Treasury 3 Month Bill ETF (TBIL), it did have positive returns over the last year. Data by YChartsThe market is confident that there will be no further rate hikes by the Federal Reserve. In fact, emboldened by the recent inflation numbers, the street now expects four-five rate cuts by the end of 2024. Expectations for another interest-rate hike from the Federal Reserve before the end of the year have shrunk to virtually zero, while traders now expect up to five rate cuts in 2024 following the release of an October inflation report. Data from the CME Group show futures traders are now pricing in virtually 100% probability that the Fed will leave interest rates on hold after their final policy meeting of the year next month. Meanwhile, they are pricing in at least four rate cuts by the end of the Fed’s December 2024 policy meeting, with expectations for a fifth cut more than doubling to nearly 23%, according to the CME’s FedWatch tool. Source: MarketWatch There is a section that thinks that the seventh time will not be the charm and history will repeat itself.  This would be the seventh time since mid-2022 that the markets anticipated a “pivot” by the Fed toward lower short-term interest rates, according to a client note penned by Deutsche Bank macro strategist Henry Allen following the CPI report. “On the previous six occasions, those hopes have been dashed, since inflation has remained too fast for the Fed to be comfortable cutting rates,” he wrote.  Source: Barrons Bond savants are siding with the rate cut consensus and that is reflected by the rising bond prices. VGSH, a beneficiary of that sentiment, also made an upward move. Data by YChartsWe review this fund in light of the current groupthink on rate cuts and provide our verdict. The Fund VGSH has very nominal annual operating expenses of 0.04%, three fourths of which is for management fees. The fees are low as the fund follows a passive investment strategy. At the beginning of this piece, we had noted that this ETF holds a portfolio of US Treasuries maturing between 1-3 years. These securities are selected from the incumbents of the Bloomberg U.S. Treasury 1-3 Year Index, using the sampling method. The Fund invests by sampling the Index, meaning that it holds a range of securities that, in the aggregate, approximates the full Index in terms of key risk factors and other characteristics. Source: VGSH Summary Prospectus By passively picking securities from the index, this fund aims to replicate its performance. One of the fund's handicaps is the fact that unlike the fund, the Index does not have any expenses. However, the 0.04% in annual fund expenses ensures that the VGSH underperformance versus its benchmark index is as nominal as its operating costs. VGSHSeeing how well VGSH tracked the index, we could not help but be impressed with the sampling procedures of VGSH. That changed when we saw the difference between the number of securities held by the two. VGSHGiven the few securities that make up the index, the fund basically buys all or close to all, of the securities held in the index and does as well as the index, net of expenses. Though the sampling part is mentioned, that is generally used on the corporate side and municipal side where the security universe is too large for even large funds to deploy into every security. The average coupon of the VGSH portfolio is 2.4%, however, the yield to maturity is twice as high at 5.1%. Not at all surprising, considering, where the rates are at right now. Data by YChartsVGSH distributes monthly, and its last payout was 18.53 cents. Using the current price of $57.78, this fund yields around 3.84%. When we covered it in September 2022, this ETF was yielding 1.24% and the yield to maturity was 2.9%. As we noted in that piece, the distribution yield would rise to meet the yield to maturity (net of expenses) and it did. This time again, we have the same scenario and investors should expect the gap to close, with the uptrend in payouts continuing over the next few months. VGSHVerdict The current consensus is calling for multiple rate cuts over the next twelve months. The consensus has been completely wrong regarding this in the past. For those that think this time will be different, there are loads of opportunities to lock in higher income for longer than what the VGSH portfolio provides. We recently wrote about one. For the crowd that thinks the that history will repeat itself, why would you take the close to 2-year duration risk that comes with owing VGSH? More importantly, today you are buying in after the rate cuts are priced in. So if does not happen you lose out. Staying nimble with a shorter term iShares 0-3 Month Treasury Bond ETF (SGOV) or US Treasury 3 Month Bill ETF (TBIL) would be the way to \"swim in place\" until the time comes to lock in higher rates for longer.  Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2385566089"}