Vanguard Short-Term Treasury ETF Offers Safety But With A Low Yield (NASDAQ:VGSH)

ETF Overview

Vanguard Short-Term Treasury ETF (VGSH) focuses on short-term investment-grade bonds in the United States. VGSH has very low credit risk as its portfolio of U.S. treasuries are backed by the full faith and credit of the U.S. government. It also has a very low interest-rate risk due to its short average duration to maturity years. However, its yield to maturity of 0.2% is low and hence it will not be suitable for investors who want higher yields.

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Fund Analysis

If safety is your number 1 concern, VGSH meets this criterion

For investors who want safety, VGSH may be a good choice for you. The name of the fund, Vanguard Short-Term Treasury ETF, means that its portfolio of bonds is all U.S. treasuries. This is probably one of the safest bonds to hold on earth right now as they have superior credit ratings. Since the formation of the U.S. government in 1776, the U.S. Treasury has never failed its lenders. In a post-COVID-19 world where many other emerging markets are still struggling to contain the virus, treasuries backed by the full faith and credit of the U.S. government should be extremely safe.

Source: Vanguard Website

VGSH’s low average effective maturity year means interest rate risk is low

VGSH tracks the Bloomberg Barclays U.S. Treasury 1-3 Year Index. This index includes U.S. treasuries that will mature between 1 and 3 years (see table below). In fact, its average effective maturity year is about 2 years.

Source: Vanguard Website

We know that some bonds have very long maturity years such as 20-year U.S. treasuries. Therefore, VGSH’s average effective maturity of 2 years is short. This short effective maturity is advantageous especially if you are concerned about rising interest rates in the future. Unlike long-term bonds, short-term bonds are less sensitive to the change of interest rates because they only have a few years left before maturing. Therefore, in a rising interest rate environment, the magnitude of the decline of short-term bond’s price is much lower than long-term bonds. For reader’s information, in the last rising interest rate cycle (between late 2017 to late 2018), VGSH’s fund value has declined by only 2%. At this moment, we do not think the Federal Reserve will be in a hurry to move to raise its interest rate anytime soon. In fact, the Federal Reserve projects that interest rate will remain near zero at least until 2022. This is because many sectors are still hurting from the outbreak of coronavirus and it is important to keep the interest rate low in order to support many suffering industries. Therefore, we are likely going to continue to experience this low-interest environment for a while unless a vaccine is developed.

VGSH’s yield to maturity is only 0.2%

Although there is no credit and little interest rate risk, investors of VGSH only receive an interest income with a yield to maturity of 0.2%. This is low. For investors that want a higher return with low credit risk, you may have to seek funds that have higher exposure to investment-grade corporate bonds. Two other alternatives include Vanguard Shor-Term Bond ETF (BSV) and iShares Short Maturity Bond ETF (NEAR). About one-third of BSV’s bonds are investment-grade corporate bonds and the fund offers an average yield to maturity of 0.7%. On the other hand, NEAR has an even higher percentage of investment-grade corporate bonds and offers an even better average yield to maturity of 1.45%.

Investor Takeaway

If your goal is to seek safety and earn some bond interest with a yield of 0.2%, VGSH maybe right for you. However, if your goal is to seek higher yield but still maintain some level of safety, this fund may not meet your need. You will have to find other investment-grade corporate bond funds with higher yields.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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