A "Real" Loser

I am an advocate of long term strategic investing.  The idea is that investment trends are likely to play out over a long term horizon and trying to outguess the markets in the short term has proven to be a tough act to beat.

However, a long term strategic approach does NOT mean “buy and hold” forever!  Case in point is the crazy situation with the U.S. Treasury market.  As I wrote in a recent blog post, Once Again, Why Bonds?, with U.S. Treasury yields so low, it is almost foolish to buy (or even hold!) that bond sector in this market.  When the 10-year treasury yield was at 0.75% and with an inflation rate of 1.3%, the “real” yield after inflation is negative 0.55%.  Moreover, with the Fed targeting an inflation rate of 2%, the “real” rate could be even lower if rates don’t rise from there.  Better to buy something with some credit spread or credit support in other parts of the bond market to get some positive “carry” with a prospect for higher return (with requisite more risk).

Short term Treasuries offer an even worse prospect for yield and return.  For an investor hoping to balance out their portfolio with an allocation to short-term (and “risk-free”) Treasuries, this investment thesis has been turned on its head! 

This dire situation is best told by looking at the current profile of the Schwab Short Term US Treasury ETF (SCHO).  Remarkably, it currently offers a 30-day SEC yield of 0.09% (essentially zero!) with a shortish duration of 1.94 implying some price sensitivity to a spike in interest rates.  This situation virtually locks in a 0% return with NO prospect for any upside return; not something that makes sense for most investors.

Additionally, it doesn’t even make sense as a diversifier in a portfolio since it does not have enough price sensitivity or negative correlation to offset equity market losses. The best case is that this investment will provide liquid cash-like returns (0%!) and perform “less worse” than other investments; why not just hold cash in a mattress, or in a bank where you at least get free FDIC insurance for $250k per holder per bank?

Long term strategic allocations of SCHO that were bought as a diversifying short term bond allocation no longer make sense in this current environment due to the distorted risk/return profile. The SCHO ETF still has $7.3 billion in assets under management, so it does serve a purpose, though a limited one.  SCHO should only be held as a cash proxy with the requisite give-up in yield, return, and diversifying properties