Don't Overlook This Bond ETF as a Portfolio Diversifier

Photograph: Getty Images Close

Photograph: Getty Images


Photograph: Getty Images

Diversifying your portfolio sounds simple. To balance out risks, you add some international stocks here, a little real estate there, maybe a commodity fund. But with asset classes moving more in concert in recent years, it's harder to find investments likely to zig when others zag.

Recent articles point to ETFs tracking gold and corporate bonds as the "last diversifiers." Another fund deserves to be on that list: the iShares 20+ Year Treasury Bond ETF (TLT). It has better performance numbers than gold and corporate bond ETFs, and its consistent returns have not tracked the stock market in the short- or long-term.

The reason TLT isn't on everyone's list of good diversifiers is simple. Most people expect interest rates to rise over the long run, and long-term Treasuries are particularly sensitive to rate increases. If and when rates rise, the Treasury bonds in TLT will be worth less because they pay less interest than the newer bonds. In an environment where the economy's growing, stocks are rising and rate increases seem imminent, TLT has some strikes against it.

If the stock market looks shaky and the economy is sluggish, however, rates aren't likely to rise. So if stocks tumble and volatility rises, TLT can provide valuable ballast. There's also a relative value argument for U.S. government debt when compared with sovereign debt in many other developed nations, as this story notes.

Looking at the past three weeks, TLT has moved in the opposite direction of SPDR S&P 500 ETF Trust (SPY) on 13 of 16 trading days. Meanwhile, SPDR Gold Shares (GLD) and iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) moved opposite the stock market 10 times. Over the same period, SPY was down 2.3 percent, TLT was up 1.3 percent and GLD and LQD were flat.

Go further back and the pattern still holds. In the last 26 quarters, TLT moved opposite SPY in 19 quarters. GLD did so for 13, and LQD for 12. So GLD and LQD moved with SPY at least half the time.

TLT proved its diversification chops back in 2008, the last time the stock market tanked. Back then, SPY went down 37 percent. TLT gained 33 percent, offsetting nearly all the losses of the S&P 500. GLD rose 3 percent and LQD was flat.

Granted, it was a different world in 2008. The Federal Reserve hadn't started a long-term bond-buying program that keeps rates artificially low, and 30-year Treasuries were yielding 4.8 percent. But when you look at more recent downturns, such as the 3.4 percent stock market drop in January, 2013, TLT still gained, this time 6 percent.

Balancing out stock market risk with TLT isn't necessarily the best or only answer. But the ETF deserves to be part of the discussion.

More stories from Eric Balchunas:

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Eric Balchunas is an exchange-traded-fund analyst at Bloomberg. More ETF data is available here, and weekly ETF podcasts can be found here.

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