Cash parking choice: an overview of ETF and iShares SHY alternatives
When we last hedged the iShares 1-3 Year Treasury Bond (SHY) ETF, we clearly tended to stay on the sidelines. Specifically, we said,
But to park it in SHY and earn less than 10 basis points a year just doesn’t make sense. Still, $ 19 billion is parked there and the premium is around 3 months of net return.
Source: A cash parking choice for shy investors
Now while we would like to congratulate ourselves for telling you that you are wasting your time here, even we were surprised to see what the total returns were from that point on.
A loss of 0.87% isn’t much, but it’s not what you’re supposed to take when cash is the asset you’re targeting. What happened and can it be an opportunity for you? We are looking at this today.
Risk without return in action
Investors who bought SHY at this point have lost about 10 years of performance, demonstrating what we have been calling Treasuries for some time. Risk without return. While SHY offered an astonishing net return of 9 basis points, it had an average duration of almost 2 years. A term of 2 years means that a 1% sudden increase interest rates would reduce the NAV by approximately 2%. Real yields rose about 64 basis points on two-year Treasuries.
This would therefore imply a drop of 1.28% of the net asset value. The actual drop was smaller because it did not happen immediately. The implied duration of the fall in the net asset value is only precise for an immediate movement. Slower movement will reduce the impact as the fund has more maturing assets during this period with a chance to reinvest in higher returns. Slower movement also allows the fund to earn more interest in the meantime. So the decline is roughly equivalent to what you would expect for the 64 basis point move in the 2-year yield.
The duration of SHY remains unchanged, but the replacement of old bonds with new ones as well as the fall in prices of existing bonds altered the SEC’s performance. It is now at 0.56%.
That’s a big improvement over the 0.09% (James Bond strike distance) you got last time around. From a money perspective, it still stinks. Not only is this much lower than inflation, it’s still a small return for the current duration risk. Obviously, over $ 20 billion does not agree with our point of view.
What to buy instead?
Lucky for you, we’ve looked at alternatives that you might normally find worthy of consideration. PIMCO Enhanced Short Maturity Active Exchange-Traded Fund (MINT) is the one we wrote about previously. With an SEC return of 0.44%, you certainly get paid less.
But MINT has a term of 0.78 years on its bond portfolio. This probably makes it a better bet in case the rates continue to rise.
BlackRock Short Term Bond ETF (NEAR) is another one we cover for investors. This one actually has the most interesting profile. The SEC yield corresponds to that of SHY and its effective duration is much shorter.
How exactly does NEAR achieve this level of return with less duration? The answer is that it is sliding down the credit quality scale.
We don’t see this as a major risk, especially over this period (around half a year). The fund is very well diversified, so a single issue won’t do that either.
Where to get real return?
Obviously, these fund returns will not satisfy anyone. However, with any additional return you get comes additional risk. This risk can be a duration risk, an equity risk or a credit risk. We’re going to go over some things we like here for return, but keep in mind that we take one or more of the risks mentioned above. We just think the reward justifies the risk in these coins, unlike what we see in the rest of the market.
For Canadian investors, we continue to invest heavily in Diversified Royalty Corp’s convertible debentures (OTCPK: BEVFF) which trade on the TSX under the symbol DIV.DB. We remain neutral on common stocks, but convertible debentures traded on the TSX offer a yield of 5% more to maturity in less than 12 months. You are sacrificing relative liquidity here because getting out in 3 seconds is not always possible with this security. Basically BEVFF shoots all cylinders with 3X interest coverage and they recently increased their dividend. Liquidity is more than sufficient and the issue is very low, barely C $ 55 million.
For US investors, we like the preferred shares of American Finance Trust Inc. (AFIN) AFINO and AFINP. Here you take a lot more risk in terms of duration and the full description of these titles can be read here. We like performance to track and believe you get paid adequately to keep up.
SHY’s performance has improved significantly since we last covered it. We prefer NEAR here because the duration risk is lower. Neither performs well, but at this point, at least, the chances of losing money are much lower. We like the idea of taking selective credit risk where the market pays us a lot more to do so. The titles linked to BEVFF and AFIN offer this in this market.