Short duration Treasury ETFs gain favor as rates reverse course and push higher

Published Fri, Feb 24 202311:52 AM ESTUpdated Fri, Feb 24 202312:01 PM EST

Jesse Pound @/in/jesse-pound @jesserpound

The recent move higher in Treasury yields appears to be sparking a shift back into short-term bond funds by investors. Friday's hotter-than-expected PCE report is the latest sign that inflation may not be slowing as fast as investors hoped just a few weeks ago. The 10-year Treasury yield is threatening to climb back above 4%, and the 6-month yield has already topped 5%. And in the ETF space, investors are voting with their feet. The three biggest funds for inflows over the past week were short-term Treasury ETFs, led by the iShares Short Treasury Bond ETF (SHV) , according to FactSet. When interest rates are rising, short-term bonds become more attractive for investors. For one, the yield curve is currently inverted, meaning that investors can get higher yields from shorter-duration Treasury bills than from longer-dated notes and bonds. The shorter duration bills are also at less risk if rates rise higher than expected. For example, if the Federal Reserve brings its benchmark interest rate near 6% later this year, then long-term bonds are likely to fall in value. A 6-month Treasury bill, however, would have already expired and repaid the principal back at the end of the year, allowing investors to redeploy that cash in another high-yield short-term instrument. The move into short duration Treasury ETFs also comes as inflows to equity funds have been tepid in recent weeks, even when stocks were rallying. "If you're getting 5% on 12-month bills or whatever duration you want to pick, then that's legitimate competition for the first time since ETFs really exploded," said Todd Sohn, ETF strategist at Strategas. Curiously, some funds that are tailored to outperform in rising rate environments, like the SPDR Blackstone Senior Loan ETF (SRLN) and the Simplify Interest Rated Hedge ETF (PFIX) have actually seen outflows recently. The FolioBeyond Rising Rates ETF (RISR) , which invests in a slice of mortgage products that benefit from higher rates, is still under $100 million in assets despite outperforming in 2022. Some investors and advisors may not be comfortable with the more specialized products, Sohn said, which could be keeping the funds from benefiting from the rate reversal. "I think it's too complicated for people even though it worked really well in the last year and a half. Just shows you how hard this industry is," Sohn said.