Markets

Extended Duration ETFs Head to Head: EDV vs ZROZ

With the Fed still hesitating to hike the benchmark interest rates even almost after a decade, bond investing prevails. In any case, September was a chancy month for the lift-off. But a global market rout in August led by the Chinese market crash, slouching commodities and their shockwaves on other emerging economies held the Fed back from catapulting a lift-off (read: ETF Winners & Losers Post Dovish Fed Meet ).

Not only this, the Fed slashed its projection for the benchmark interest rate for 2015, 2016 and 2017. The Fed's funds rate for the longer run was cut to 3.0-4.0% from 3.3-4.3%, suggesting a slower rate hike trail. The expectation for 2015 real GDP growth has been upgraded to 1.9-2.5% from 1.7-2.3% projected in June while the same for 2016 was lowered to 2.1-2.8% from 2.3-3.0%.

This economic backdrop pulled down the bond yields and drove up bond prices, especially the long-term ones. Yield on the benchmark 10-Year U.S. Treasury note plunged to 2.16% on September 23 from 2.54% recorded in the year-ago period. Yield on the 30-year U.S. Treasury note fell 50 bps to 2.75% on September 23.

This, along with geopolitical uncertainty, global slowdown, stubbornly low oil prices and deflation fears are also driving demand for safe-haven bonds. Since long-term bonds offer up greater yield in this yield-starved economy, investors thronged to the long-dated Treasury bonds and the related ETFs (read: Are Treasuries the Best Safe Haven ETFs Now? ).

Investors should note that U.S. long-term Treasury bonds turned out compelling investments in 2014. Though the looming Fed lift-off is a negative for U.S. treasury ETFs, 10-year U.S. Treasuries outdid their Group of Seven counterparts in the August equities collapse, as per Bloomberg .

In such a scenario, it would be intriguing to look at two top performing long-term U.S. Treasury bond ETFs and their key differences:

Vanguard Extended Duration Treasury ETF ( EDV )

For a long-term play on the bond market, investors have EDV, a fund that seeks to match the performance of the Barclays U.S. Treasury STRIPS 20-30 Year Equal Par Bond Index. This means that this benchmark zeroes in on fixed income securities that are sold at a discount to face value, and then the investor is paid the face value upon maturity.

As such, these bonds are usually very sensitive to interest rate changes, and can be greatly impacted by shifting rates. This particular 73 bond basket has an average maturity of 25.2 years, and a yield to maturity of 3%. The effective duration of the ETF stands at 24.8 years suggesting high interest rate risks. The fund has amassed about $364 million in assets.

Investors should also note that this is a cheap product, as it charges just 12 basis points a year, so it will be a very low cost way to get into long duration bonds. However, the real selling point as of late has been price appreciation as EDV gained about 3% post Fed meeting in September. However, the fund has lost about 6% in the year-to-date time frame on rising rate worries. In the last one year (as of September 23, 2015), the fund was up about 6.4%. This Zacks Rank #2 (Buy) ETF yields 2.99% annually.

PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF (ZROZ)

This ETF follows the BofA Merrill Lynch Long US Treasury Principal STRIPS Index, which focuses on Treasury principal STRIPS that have 25 years or more remaining to final maturity.

The product holds 20 securities in its basket. Both the effective maturity and effective duration of the fund is 27.22 years. This fund is often overlooked by investors as depicted by AUM of $182.74 million.

The product charges 15 bps in annual fees and returned 3.8% in the last five trading sessions (as of September 23, 2015) reflecting a dovish Fed. The fund was up over 6% in the last one year while so far this year the product has shed about 6.7%. The fund yields 2.92% annually and has a Zacks ETF Rank #2 (read: Will Long Term Treasury ETFs Continue to Soar in 2015? )

Since, ZROZ has a little higher duration and maturity, it can outperform when rates are downhill; but with the Fed preparing for a lift-off sometime in 2015 or as late as early 2016, ZROZ will likely lag EDV going forward.

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VANGD-EX DUR TR (EDV): ETF Research Reports

PIMCO-25Y ZERO (ZROZ): ETF Research Reports

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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