With tapering off the table for the foreseeable future, Larry Summers not getting the nod for Fed Chairman, and nothing indicating a change to the slow-growth economy in which the U.S. is mired, some investors may be thinking about allocating money to U.S. Treasuries. For those investors, I have the following suggestion: Don’t waste your time with TLT.
The iShares 20+ Year Treasury Bond ETF, ticker symbol TLT, is a popular way to gain exposure to long-term U.S. Treasury bonds. The fund invests in a number of different individual Treasury bonds, all of which have remaining maturities of greater than 20 years. If you are looking for exposure to long-term U.S. Treasuries, TLT can help you accomplish this. But I think there is a better way to get your exposure. Instead of buying TLT, investors looking for exposure to long-term Treasuries would be better off buying individual Treasury bonds.
If you were to debate a proponent of investing in bond funds over individual bonds, you would likely hear the following two things:
- It is too expensive to build a diversified portfolio of individual bonds, both in terms of the total dollar amount needed, and in terms of the costs associated with trading a number of bonds.
- A proponent of investing in bond funds over individual bonds is also likely to mention superior liquidity in bonds funds as a reason to go that route.
When it comes to building exposure to long-term Treasury bonds, however, I do not think either of these arguments hold any water. Concerning building a diversified portfolio of those securities underlying TLT, just pick a few Treasury CUSIPs in the 20-to-30-year range. The U.S. Treasury is the issuer of all of TLT’s underlying securities (short-term “cash equivalents” the lone exception). You could even pick one CUSIP if that suited you better and still get essentially the same performance as TLT will provide. The benefit, however, to buying the individual bond, is that you won’t be forced to sell it as it approaches 20 years to maturity. Instead, the duration of your Treasury holding(s) would continue to decline over time, whereas TLT’s would remain relatively constant. Additionally, concerning costs, it is now possible to trade individual Treasuries at several brokers for $0. A price of $0 on a Treasury trade is likely less than most people are paying to buy TLT.
Regarding the idea that bond funds offer better liquidity, this may be the case in certain parts of the bond market. But in the Treasury market, I beg to differ. There is perhaps more liquidity in the Treasury market than in any other market worldwide. Individual bonds may have a bad reputation for wide bid-ask spreads, but Treasuries are certainly an exception to that rule. When buying individual Treasuries, you will discover narrow spreads and ample liquidity.
I will concede that if you want to trade options on Treasuries, TLT is one avenue to accomplish that. And I should also point out that there are some occasions when the bond market is closed, and it is still possible to place trades on TLT. Other than that, I simply don’t see the benefit of owning TLT over individual Treasury bonds.
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