Most of us have been affected by the financial crisis of 2008. There are reasons to fear a double dip recession globally and in the US. If you are interested in hedging your portfolio against a future crisis and the resulting steep decline in stocks, consider allocating some of your investment money to the Vanguard Extended Duration Treasuries ETF (EDV).
This fund is made up of very long-term US treasury bonds (20 to 30 years). Because of the long maturity of these bonds they are extremely sensitive to interest rate risk. So this ETF is considered “high-risk.” Indeed it has a high standard deviation (about 28.7). That’s more like a stock fund than a bond fund. However, this fund’s returns have a negative correlation to the stock market returns. This means, the fund’s value goes up when the stock market goes down and vise-versa (see the chart below).
The red line shows the returns of the Vanguard Total Stock Market Index (VTSMX) fund, the yellow line shows the returns of the Vanguard Total Bond Market Index (VBMFX) fund and the blue line shows the returns of the Vanguard Extended Duration Treasuries ETF for the past 4 years. As you can see EDV’s price is clearly negatively correlated to the stock market price. This is due to investors fleeing the stock market (and even bonds) to what is considered the safest securities US treasuries. These bonds are considered to have zero risk of default since the US government has never defaulted on its bonds. The yield on this fund is currently 4.25%.
Few caveats about EDV
1) Vanguard says “the fund is primarily intended for institutional investors with extremely long-term liabilities—20 years or more. Prospective individual investors are urged to consult with their own advisors to determine if the fund is suitable for their overall investment programs and financial positions.”
2) Note that EDV did not outperform Vanguard Total Bond Index (VBMFX) during the 4 years it has been in existence. So again the object of this fund is first and foremost as a hedge for those concerned about a repeat of the 2008 steep decline in stocks. Secondly, this fund has a high yield consistent with its very long duration.
3) Morningstar does not like this fund. It gives it a single star. I believe Morningstar is rating EDV against other bond funds and not as a hedge against stock declines. While they do provide a rating for EDV they do not have analyst commentary for it.
4) If and when interest rates rise this fund will suffer more than bond funds with shorter durations (see bond mutual funds).
5) Finally, just because the fund performed well thus far as an instrument with a negative correlation to stocks this does not mean that it will always do that. If investors start doubting the US government’s ability to reduce its debt this might change.
Finally, EDV (or a similar long-US Treasuries fund) is a good fund to own in the range of 3% to 5% of your portfolio as a hedge against steep stock declines. In other word this is not a core holding but a fund that will play a good supporting role in a well balance portfolio.