Here’s a question advisors are asking these days: If I can get my clients 5% in T-Bills, why would I consider longer dated treasury or corporate bonds?
Good advisers understand their clients can earn more than 5% these days on U.S. Treasury bills (T-Bills) and bank certificates of deposit. Inflation notwithstanding, this guaranteed number is high enough to offer a competitive return with some portfolio protection – a benefit investors haven’t enjoyed post-Global Financial Crisis. When the path of least resistance for safe money is T-Bills, it’s easy to understand why an advisor might think twice before recommending anything dated longer than six to 12 months.
Not the Same Fixed Income Market
Until last year, the Fed had kept interest rates near zero for 15 years. Bonds, like stocks, had become an asset that produced capital gains. Along came 2022 and its string of rate hikes, collectively having driven the overall bond market down some 13%, long-term Treasuries dropped more than 20%. These crashing prices, of course, created the higher yields we’re seeing today.
As of June 9, investors could earn 5.14% on a six-month U.S. Treasury bill, free of state and local tax. Ten-year Treasuries, meanwhile, were yielding 3.74% while 30-year bonds were offering 3.88%. You could also buy BBB-rated high-quality corporate bonds yielding 5.79% and BB-rated high-yield corporates in the 7.06% range. Simply put, bonds are producing income again.
Understanding Duration and Price
The total return of a T-Bill is essentially limited to its interest income. Buying longer-dated bonds, on the other hand, not only locks in today’s attractive current yields, but positions investors to boost their total return through capital price appreciation.
Duration, a measure of a bond’s price sensitivity to interest rate changes, is a powerful tool for capturing capital price appreciation.
While duration is usually talked about in simple terms, we believe that a deeper understanding of the measurement is vital in today’s market with prices having declined so significantly in the wake of Fed rate hikes. By definition, duration is the amount a bond’s value is calculated to increase or decrease with a 1% change in interest rates. Unlike maturity, duration accounts for interest payments that occur throughout the life of the bond.
Why does it matter? Suppose you purchase a 6-month T-Bill today* at 5.14%. If interest rates fall by 25 basis points in six months when it’s time to roll into another bill, your total return will be around 5.02% over the full twelve months. However, if you purchase a generic BB-rated bond, say the Warner Music Group 3% notes due 2031 currently yielding 6.11%, and hold that security for one year while interest rates decline 25 basis points, the total return will be 7.66%. If rates were to fall further than 25 basis points, the return for the longer-dated bond would be even higher, and the missed opportunity from staying in T-bills even greater. This concept is known as Reinvestment Risk. The concept would hold true for longer-dated Treasuries as well; a 10-year UST yielding 3.74% would generate a total return of 5.67% if rates decline 25 basis points in six months.
The Difference Is Worth Thinking About
For years now, Wall Street has been promoting ‘alternative products’ to investors desperate for anything with higher yields. All were sold on the notion you needed to take extra risk to get extra income. Today, you don’t. We’re aware that financial advisors are parking cash in short-term T-Bills yielding more than 5%. That may be a viable solution, but the investor is missing out on potential capital appreciation. So, take what the market gives you and welcome the total return potential of longer-dated, high-duration bonds. You can and you should.
Peter Higgins is Head of Fixed Income and Senior Portfolio Manager at Shelton Capital Management
Important Information
It is possible to lose money by investing in a fund. Past performance does not guarantee future results. Any projections or other forward looking statements regarding future events or performance of markets, companies, or otherwise are not necessarily indicative or differ from, actual events or results.
Investors should consider a fund’s investment objectives, risks, charges, and expenses carefully before investing. The prospectus contains this and other information about the fund. To obtain a prospectus, visit www.sheltoncap.com or call (800) 955-9988. A prospectus should be read carefully before investing.
INVESTMENTS ARE NOT FDIC INSURED OR BANK GUARANTEED AND MAY LOSE VALUE.
*June 9th 2023
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