Investors are finding that a bond’s issuer is only part of what determines its risk.(Photo by Mario Ruiz/Getty Images)
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The iShares 20+ Year Treasury Bond ETF (TLT), with $45.4 billion in net assets, fell to its lowest price in 22 years Tuesday, down 6% since the start of the year, as the yield on 30-year Treasury bonds climbed above 5.33%, its highest level since 2007. The fund is run by BlackRock, the world’s largest money manager, with $15.3 trillion under management as of June 30.
What is causing the sell off in bonds? Oil prices above $90 have renewed fears that inflation will stay high. The federal government ran a $432.3 billion deficit in July, its largest monthly shortfall since March 2021, and must keep selling debt to cover the gap. Technology companies are on track to borrow half a trillion dollars this year to build artificial intelligence infrastructure, giving investors more bonds to choose from. All this translates into higher interest rates and lower bond prices.
Those forces explain why TLT and many other bond funds are down. They don’t explain why it has lost so much more than other bond funds.
BlackRock offers funds for every corner of the bond market. Its long-term Treasury fund is down 4.22% this year while its junk-bond fund is up 2.6%. A fund holding Treasury bills, which mature in three months or less, has gained 2.27%.
Junk bonds, which in some ways behave more like equities, often outperform government debt, especially when the economy is strong and defaults remain low. But this year’s split highlights something the word “safe” can obscure. Treasurys carry little default risk, but they can still lose money when rates rise, particularly when repayment is decades away.
BlackRock’s own funds show what’s happening. The bond market is punishing time more than credit risk.
The key metric driving bond prices is what’s known as effective duration, which measures how sensitive a bond’s price is to changing interest rates. When rates rise, the prices of existing bonds fall because investors can buy new bonds paying more. When rates fall, existing bonds paying higher rates become more valuable.
Duration puts a number on that sensitivity. A fund with a duration of three years would be expected to lose about 3% (of its price) if rates rose by one percentage point, or gain about 3% if rates fell by the same amount. TLT’s duration of 14.81 years points to a price move close to 15% under either of those scenarios.
That explains why the iShares Broad USD High Yield Corporate Bond ETF, with $29 billion in net assets, has held up. Its companies are riskier, but its duration is much shorter than TLT’s at just 2.96 years. It also yields 7.02%, giving investors more income to offset a drop in price. The economy has remained strong enough that fears of widespread defaults haven’t erased that advantage.
The iShares iBoxx $ Investment Grade Corporate Bond ETF, with $33.4 billion in net assets, owns debt from safer companies, those rated above triple-B. But its duration is 7.67 years, and it has lost 1.21% this year. The borrowers are safer than what you find in the junk bond index, but the wait is longer.
At the shortest end, the iShares 0-3 Month Treasury Bond ETF, with $103.2 billion in net assets and a current yield of only 3.6%, holds bills that mature in three months or less. The fund gets its money back and reinvests at current rates. That has kept its price steady while it collects interest.
TLT is on the opposite end of the spectrum. Its 14.81-year duration leaves it exposed when long-term rates rise like they are now. Investors would benefit if rates fell, but this year they have moved in the wrong direction.
None of this makes junk debt safer than Treasury bonds. But it does show that “safe” can mean different things. Treasurys are safer from default. Shorter bonds are safer from changing rates.
So far this year, the second kind of safety has mattered more.
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