ETF Overview

About 8 months ago, I have written an article to analyze Vanguard Extended Duration Treasury ETF (EDV). At that time, I was bearish because I thought the economy will gradually re-accelerate, especially after the trade deal between China and the U.S. is signed. However, the outbreak of COVID-19 has changed the macroeconomic outlook. Therefore, it is time for me to write an article to discuss the outlook of EDV again. EDV has little credit risk as its portfolio consists of U.S. treasuries that are backed by the full faith and credit of the U.S. government. Since the Federal Reserve will likely not raise its interest rate before 2022, and that it will not pursue negative interest rates, EDV’s fund price will likely be rangebound in the near term. Meanwhile, investors will be able to earn some interest income with an average yield to maturity of 1.5%.

Data by YCharts

Fund Analysis

EDV is very safe with extremely low credit risk

EDV tracks the Bloomberg Barclays U.S. Treasury STRIPS 20-30 Year Equal Par Bond Index. Therefore, its portfolio consists of mainly U.S. treasuries. U.S. treasuries are likely one of the safest bonds to hold on earth now as they have the best credit ratings. Since the formation of the U.S. government back in 1776, the government has never failed its lenders. In a post-COVID-19 world, we favor U.S. treasuries over government bonds issued by other emerging markets. Not only because most emerging markets have inferior credit ratings than the U.S. government, the U.S. has much better healthcare resources than many emerging markets. This is important because the U.S. has likely already passed the peak of the pandemic, while many other emerging markets have yet to reach the peak. Therefore, we think the economy in the U.S. will recover much more quickly and hence support its credit rating.

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Source: Vanguard Website

EDV’s long average effective maturity year means its interest rate risk is high

EDV consists of U.S. treasuries that have long duration to maturity. As can be seen from the chart below, 100% of the treasuries that EDV owns will mature 20 to 30 years from now. In fact, it has an average effective maturity year of 25.3 years. Unlike short-term bonds, long-term bonds are much more sensitive to the change of interest rates because rates could change dramatically in the next 20 to 30 years. In a rising interest rate environment, bond value may decline dramatically. On the other hand, bond value will rise in a declining interest rate environment.

Source: Vanguard Website

The question is what the rate environment will be like in the next few years. Fortunately, 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, this low interest rate environment will likely stay for a lengthy period of time unless a vaccine is developed. This will likely not happen at least 1 or 2 years from now (perhaps even longer). For investors wanting capital appreciation, we do not think EDV is a good choice either. This is because the Federal Reserve has made it clear that it will not lower its rate into negative territory. Therefore, EDV’s fund value will likely be rangebound in the next 1 to 2 years.

Investor Takeaway

We think EDV’s fund value will be rangebound in H2 2020 and 2021. Meanwhile, investors of EDV will receive interest income with an average yield to maturity of 1.5%. Therefore, this may still be a good fund to own and earn some interest income in the near term.

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.