ABREAST OF THE MARKET
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May 20, 2012, 5:12 p.m. ET
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Walking a Treasury Tightrope
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By BEN LEVISOHN and MATT PHILLIPS
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Investors in U.S. Treasurys stand a good chance of losing money over time. And yet they can't seem to get enough of Uncle Sam's paper.
With the European crisis heating up and concerns about economic growth in the
U.S. and China, money once again is pouring into safe U.S. government debt,
sending Treasury prices higher and yields, which move in the opposite direction,
to near-record lows.
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The benchmark 10-year Treasury yielded 1.702% late Friday, not far from the 1.67% intraday level it hit back in September, the lowest tracked in Federal Reserve records dating back to 1962. The last time interest rates were near these levels was the early 1950s, when World War II-era interest-rate caps were in place.
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Why so much buying? Treasurys "give safety, and I get a constant yield," said John Baumann, head of institution sales and client service at PineBridge Investments, a New York asset manager focused on institutional investors such as public and corporate pension funds, endowments and foundations, with $67 billion in assets under management. "That's the only reason I want Treasury bonds."
Over the long term, however, Treasurys pose risks of their own.
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The biggest risk, experts say, is a prolonged rise in interest rates, which would reduce prices of existing bonds and produce losses for investors holding Treasurys.
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Many investors worry the three-decade-long decline in interest rates—and rise in bond prices—is nearing an end. The rally started in 1981, after then-Federal Reserve Chairman Paul Volcker ratcheted up interest rates to quell inflation. Back then the 10-year Treasury yield stood at almost 16%. It has been on a general downward path—with a few interruptions—ever since.
Tad Rivelle, chief investment officer for fixed income at Los Angeles-based TCW Group Inc., who oversees more than $30 billion in client assets, is skeptical the Treasury rally will last much longer. "If it is not over, it is far closer to the end than the beginning," he said.
Treasurys pose another big risk: With yields this low, investors could well lose money over time in inflation-adjusted terms.
The core consumer-price index, a measure of inflation, clocked in at a 2.3% annual rate in April—higher than the 10-year Treasury's current yield of about 1.7%. If that relationship persists, inflation will eat away at the fixed returns on bonds over time, leaving investors with less purchasing power when they cash in the bonds in 10 years than they have now. At current yields and prices, the only way buy-and-hold investors will make money on Treasurys is if inflation drops.
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But many money managers aren't thinking about Treasurys' low yields or long-term performance. They are rushing in because Treasurys are a safe place to stash cash in the short term.
.
"For someone concerned about exposure to capital losses, the yield on the 10-year Treasury is sort of a minor consideration," said Gregory Whiteley, portfolio manager of government securities at DoubleLine Capital, a Los Angeles, Calif., asset manager with about $34 billion in assets under management.
Last year, Europe's debt woes, uneven U.S. economic growth and the Federal Reserve's "Operation Twist" bond-buying campaign, designed to keep long-term interest rates low, created an ideal environment for Treasurys. Including price gains and interest payments, long-term Treasurys generated a 29.9% return in 2011, according to Barclays Capital index data, topping the broader bond market and easily beating the Dow Jones Industrial Average's 8.3% total return.
.
Some of those same dynamics remain in effect. The Fed is still a significant buyer of long-term U.S. Treasury debt through Operation Twist, which is expected to run through June.
.
All told, through Wednesday, investors had plowed $12.1 billion into U.S. Treasury funds this year, according to fund-flow tracker EPFR Global, while pulling more than $10 billion from U.S. stock funds.
With worries over Europe's debt crisis flaring anew, some investors have been buying Treasurys as a buffer. During the past month, the Dow industrials have shed about 6.4%, while long-term Treasurys have returned more than 5%, according to Barclays Index data.
.
Michael Brandes, global head of fixed-income strategy at Citi Private Bank, recommended in April that clients add Treasurys to their portfolios in the short term.
.
"Treasurys are not a compelling opportunity" compared with U.S. corporate bonds, Mr. Brandes said. "But during periods where there are more questions than answers, investors are more concerned with getting their money back."
.
But investors could be stung badly if the Europe crisis eases and the U.S. economy strengthens, sending interest rates higher. That's because, with yields this low, prices tend to swing wildly with relatively small changes in yields—meaning rates don't have to increase much to generate sizable bond-price declines.
.
For example, from the end of December, when the 10-year yield was at 1.88%, through the end of March, when it stood at 2.21%, investors in long-term Treasury bonds—with maturities of 10 years or more—lost about 6%, according to Barclays Index data.
.
Trading such swings in investor sentiment can be profitable, said Mr. Rivelle of TCW, if the timing is right. While he owns fewer Treasurys as a percentage of assets than he ever has, he tried to take advantage of the market's constant back and forth between risk taking and risk aversion. "It is better to [engage in] active trading than curse the market's volatility," he said.
.
But for some investors, the risks of owning Treasurys are too great. Jason Graybill, a senior managing director at Carret Asset Management LLC in New York, who helps oversee $1.2 billion in bonds, currently runs a Treasury-free portfolio.
.
"We'd like to own Treasurys," he said. "But from a risk-reward perspective, the Treasury market doesn't hold much value."
.
The benchmark 10-year Treasury yielded 1.702% late Friday, not far from the 1.67% intraday level it hit back in September, the lowest tracked in Federal Reserve records dating back to 1962. The last time interest rates were near these levels was the early 1950s, when World War II-era interest-rate caps were in place.
.
Why so much buying? Treasurys "give safety, and I get a constant yield," said John Baumann, head of institution sales and client service at PineBridge Investments, a New York asset manager focused on institutional investors such as public and corporate pension funds, endowments and foundations, with $67 billion in assets under management. "That's the only reason I want Treasury bonds."
The Big Round Trip: Yield on the 10-Year Treasury Note
Over the long term, however, Treasurys pose risks of their own.
.
The biggest risk, experts say, is a prolonged rise in interest rates, which would reduce prices of existing bonds and produce losses for investors holding Treasurys.
.
Many investors worry the three-decade-long decline in interest rates—and rise in bond prices—is nearing an end. The rally started in 1981, after then-Federal Reserve Chairman Paul Volcker ratcheted up interest rates to quell inflation. Back then the 10-year Treasury yield stood at almost 16%. It has been on a general downward path—with a few interruptions—ever since.
Tad Rivelle, chief investment officer for fixed income at Los Angeles-based TCW Group Inc., who oversees more than $30 billion in client assets, is skeptical the Treasury rally will last much longer. "If it is not over, it is far closer to the end than the beginning," he said.
Treasurys pose another big risk: With yields this low, investors could well lose money over time in inflation-adjusted terms.
The core consumer-price index, a measure of inflation, clocked in at a 2.3% annual rate in April—higher than the 10-year Treasury's current yield of about 1.7%. If that relationship persists, inflation will eat away at the fixed returns on bonds over time, leaving investors with less purchasing power when they cash in the bonds in 10 years than they have now. At current yields and prices, the only way buy-and-hold investors will make money on Treasurys is if inflation drops.
.
But many money managers aren't thinking about Treasurys' low yields or long-term performance. They are rushing in because Treasurys are a safe place to stash cash in the short term.
.
"For someone concerned about exposure to capital losses, the yield on the 10-year Treasury is sort of a minor consideration," said Gregory Whiteley, portfolio manager of government securities at DoubleLine Capital, a Los Angeles, Calif., asset manager with about $34 billion in assets under management.
Last year, Europe's debt woes, uneven U.S. economic growth and the Federal Reserve's "Operation Twist" bond-buying campaign, designed to keep long-term interest rates low, created an ideal environment for Treasurys. Including price gains and interest payments, long-term Treasurys generated a 29.9% return in 2011, according to Barclays Capital index data, topping the broader bond market and easily beating the Dow Jones Industrial Average's 8.3% total return.
.
Some of those same dynamics remain in effect. The Fed is still a significant buyer of long-term U.S. Treasury debt through Operation Twist, which is expected to run through June.
.
All told, through Wednesday, investors had plowed $12.1 billion into U.S. Treasury funds this year, according to fund-flow tracker EPFR Global, while pulling more than $10 billion from U.S. stock funds.
With worries over Europe's debt crisis flaring anew, some investors have been buying Treasurys as a buffer. During the past month, the Dow industrials have shed about 6.4%, while long-term Treasurys have returned more than 5%, according to Barclays Index data.
.
Michael Brandes, global head of fixed-income strategy at Citi Private Bank, recommended in April that clients add Treasurys to their portfolios in the short term.
.
"Treasurys are not a compelling opportunity" compared with U.S. corporate bonds, Mr. Brandes said. "But during periods where there are more questions than answers, investors are more concerned with getting their money back."
.
But investors could be stung badly if the Europe crisis eases and the U.S. economy strengthens, sending interest rates higher. That's because, with yields this low, prices tend to swing wildly with relatively small changes in yields—meaning rates don't have to increase much to generate sizable bond-price declines.
.
For example, from the end of December, when the 10-year yield was at 1.88%, through the end of March, when it stood at 2.21%, investors in long-term Treasury bonds—with maturities of 10 years or more—lost about 6%, according to Barclays Index data.
.
Trading such swings in investor sentiment can be profitable, said Mr. Rivelle of TCW, if the timing is right. While he owns fewer Treasurys as a percentage of assets than he ever has, he tried to take advantage of the market's constant back and forth between risk taking and risk aversion. "It is better to [engage in] active trading than curse the market's volatility," he said.
.
But for some investors, the risks of owning Treasurys are too great. Jason Graybill, a senior managing director at Carret Asset Management LLC in New York, who helps oversee $1.2 billion in bonds, currently runs a Treasury-free portfolio.
.
"We'd like to own Treasurys," he said. "But from a risk-reward perspective, the Treasury market doesn't hold much value."
.
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