TLT ETF: You Should Accumulate This In 2023 (2024)

Introduction

The bond market has performed poorly in the past two years. Will this trend continue in 2023? Should investors be buying shorter duration bond funds or longer duration bond funds? In this article, we will analyze iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT) and provide our strategy on investing TLT.

ETF Overview

TLT focuses on long-term U.S. treasuries. The fund invests in U.S. treasuries with a weighted average maturity year of nearly 26 years. Last year was a brutal year for TLT as the fund lost over 38% of its value due to the Federal Reserve's aggressive rate hike and the fund's high sensitivity to rate changes. Since we are likely near the end of this rate hike cycle, we think this is not a bad time to start accumulating shares of TLT. Investors should be prepared to average down on any price weaknesses.

Fund Analysis

TLT has underperformed other treasury funds in this bear market

TLT has done very poorly in this bear market. The fund has dropped more than 38% since reaching the peak in late 2020 and early 2021. In contrast, its shorter duration peers have fared much better. As can be seen from the chart below, iShares 10-20 Year Treasury Bond ETF (TLH), iShares 7-10 Year Treasury Bond ETF (IEF), and iShares 1-3 Year Treasury Bond ETF (SHY) delivered negative returns of 33.92%, 19.95%, and 5.51% respectively. Their results were better than TLT's. The decline of these bond funds in the past two years was due to the rise of inflation and especially the Federal Reserve's aggressive rate hike last year. As a result, the Fed fund rate is now at a level we have not seen since 2007.

The reason why TLT underperformed its peers was due to its portfolio's longer duration treasuries. TLT currently has a weighted average maturity year of 25.99 years. This is much longer than TLH's 17.59 years and IEF's 8.43 years. In general, the longer the duration of bonds, the more sensitive its bond price is to the rate changes. Therefore, TLT's portfolio of longer duration U.S. treasuries suffered much greater loss than its peers in this aggressive rate hike environment.

TLT's long-term total return outperformed other shorter duration treasury funds

Let us now compare TLT's total return in the long run. As can be seen from the chart below, TLT's total return of 90.79% since 2007 was much better than TLH's 72.65%, IEF's 71.93%, and SHY's 26.37%. Although TLT has the potential to deliver better return in the long run, given its higher sensitivity to rate changes, its fund price is also much more volatile than its peers.

Be prepared for some near-term weaknesses, but we may be near the end of the rate hike cycle

There are two factors that typically impact the bond market. The first factor is the change of rate. We have briefly discussed this earlier in the article. Basically, rate hike expectations tend to result in a decline in bond prices and vice versa. The impact also depends on the duration of bonds. The longer the duration of the bonds, the more sensitive its bond price is to the rate change.

As we know, inflation has resulted in the Federal Reserve's aggressive rate hike last year and the hike may continue this year due to persistent inflation albeit at a slower pace. Therefore, it is likely that we may continue to see some near-term weaknesses in TLT's fund price. However, we expect inflation to eventually cool off because it usually takes about 6 ~ 12 months for the effect of monetary policy to ripple through the economy. Meanwhile, the Federal Reserve may still need to raise the rate in the near-term to ensure inflation is not out of control. However, as soon as inflation cools off, the Federal Reserve may be able to relax its monetary policy. This will eventually result in a decline in treasury yield and TLT's fund price should go up meaningfully. However, the timeline of this may be in 2024 and investors still need some patience.

The second factor that impacts the bond market has to do with psychology. If the market is in a panic mode, such as the case we have seen in the past week due to the collapse of Silicon Valley Bank and a few other regional banks, the bond market may also react swiftly. If fear dominates, investors may rotate money out of riskier assets such as equities and non-investment grade bonds and seek shelter in higher quality bonds. Since U.S. treasury is often perceived as risk-free asset, it is a haven for many investors to park their money. Therefore, in times of panic, we expect prices of U.S. treasuries to move up. Since TLT owns solely U.S. treasuries, its fund price will also be positively impacted.

Our strategy: keep accumulating in 2023

Since we may not be far from the end of the rate hike cycle, we think 2023 may be a good time to accumulate shares of TLT. As can be seen from the chart below, the current 20-year treasury rate of 3.85% is towards the high end of the range in the past 10 years. We think this rate will eventually fall to the 10-year average of about 2.4%. Therefore, any weakness in TLT's fund price should be seen as a good buying opportunity. Investors should take advantage of this and gradually accumulate. Investors should also be prepared to average down its cost on any price weakness.

Investor Takeaway

We think now is a good time to gradually accumulate TLT as its fund price has dropped a lot in the past two years. While there may be some near-term weaknesses ahead, investors should be patient and average down on any price weakness. As soon as the Federal Reserve switches from a tightening monetary policy to an easing policy, TLT should be able to rebound meaningfully. Meanwhile, investors can still earn some bond interest with a yield of 3.74%.

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