The iShares 20+ Year Treasury Bond ETF (TLT) is one of the most widely-followed fixed-income exchange-traded funds out there; it’s also proven to be an equally big paradox.
That’s because the adage in bonds is “As interest rates rise, bond prices fall.” When bond prices fall, bond funds and ETFs suffer.
While that is true for the short run, bond funds can actually benefit from a rise in rates long-term. Let’s see how that paradox plays out in TLT.
iShares 20+ Year Treasury Bond ETF
The iShares 20+ Year Treasury Bond ETF aims to track the ICE U.S. Treasury 20+ Year Bond Index. The ETF currently offers a distribution yield of 2.50% and a 30-day SEC yield of 2.64%. Additionally, TLT has an effective duration of 17.61 years. Moreover, it had a weighted average coupon of 3.16% and a weighted average maturity of 26.20%.
That effective duration of 17.61 years means if interest rates rise instantaneously by 1%, TLT would be expected to fall by 17.61% (and the opposite is true if rates fall). Truthfully, however, that big a move is unlikely, because buyers would step in to buy the ETF at a relatively steep discount, and the resulting bounce-back from any rise in rates would be the paradox in this long-term bond fund.
If rates rise, TLT would fall short-term, but it’s a potentially different story long-run.
Here’s what you need to know. After the initial drop in bond prices after a rate hike, fund managers can reinvest the income generated from the bonds they hold at higher yields. This makes up for at least some of the short-term decline caused by the rate hike.
Thus, if you’re invested in or watching TLT, rate hikes are a factor and a short-term concern, but you shouldn’t be as stressed about the long run. because you will expect rising yields to help you out over time.
The bottom line
Although interest rate hikes cause fixed-income related securities to fall over the short term, bond funds like TLT may actually benefit over time. Factor that into your decision-making as you determine if a long-term bond fund like TLT is worth a piece of your portfolio.
Jeff Bishop is lead trader at TopStockPicks.com. He runs short-term trading strategies, using stocks, options and leveraged ETFs.
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