SPTL: A Balance Between Income And Duration, But I Remain On The Sidelines (SPTL)

In the context of where Treasury rates have been in the last fifteen years, the current >4.5% for longer-duration bonds might seem attractive enough to lock in via a vehicle like the SPDR Portfolio Long Term Treasury ETF (NYSEARCA:SPTL). But unlike individual bonds that can be held to maturity and are therefore insulated against interest rate swings, SPTL’s combination of maximum interest rate risk and monthly reconstitutions makes the fund’s risk/reward a lot different.

For one, there hasn’t been much improvement at all in the supply/demand dynamics of Treasury bonds since I last covered the fund (see SPTL: Beware The Long-End Of The Treasury Curve). In fact, recent data from the IMF estimating US fiscal deficits hit a worrying 8.8% of GDP last year (vs ~4% in 2022) indicate things may actually have gotten worse. The other problem is that the discretionary spending share (i.e., the portion that the government can cut) is also declining in place of interest costs. Expect things to get worse before they get better, as deficits tend to run higher during an election year – particularly if it’s a tightly contested one.

Either way, the US government will need to continue funding its deficits by issuing debt and, therefore, increasing Treasury supply. Thus, demand for Treasuries must continue to match this pace, else yields may actually grind higher, thereby inflicting losses on long-duration funds like SPTL. Of course, the inverse is also true, though with ‘sticky’ inflation limiting the Fed’s ability to outpace rate cut expectations and the Q2 refunding announcement also indicating Treasury buyback sizes will run at a slower pace than expected, I don’t see a particularly compelling case for exposure. Net-net, I’d stick with lower duration, higher-yielding T-bills for risk-free income.

SPTL Overview – The Lowest Fee Long-Term Treasury Fund

The State Street-managed SPDR Portfolio Long Term Treasury ETF has mostly kept its fundamentals intact. This remains a tracker fund benchmarked to the capitalization-weighted Bloomberg Long US Treasury Index, a basket of Treasury securities subject to the following key criteria – maturities over ten years and face values of over $300m outstanding.

SPTL still isn’t the biggest long-dated Treasury fund, but it has seen significant growth in recent quarters, hitting ~$9.0bn of managed assets. One key reason for its growing popularity is its 0.03% expense ratio, which places it ahead of key alternatives like the iShares 20+ Year Treasury Bond ETF (TLT) and Vanguard’s Long-Term Treasury Index Fund ETF (VGLT), which charge higher 0.15% and 0.04% fees, respectively.

The catch is that SPTL, by virtue of its smaller asset base, also trails its peers on liquidity, as reflected in its wider 4bps median bid/ask spread (vs ~1bps for TLT and ~2bps for VGLT). SPTL is catching up in size, though, and when it does, this gap will probably narrow over time. In any case, for long-term investors moving smaller volumes and who don’t need best-in-class execution, SPTL still ranks highly on cost.

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Source: State Street, iShares, Vanguard

SPTL Portfolio – Balancing Income and Risk

Of note, there has been some reshuffling to the fund’s portfolio, now spread across a slightly narrower 82 Treasury holdings. While its largest allocation remains the longest end of the curve, the % contribution has shifted from 20-30 year (down to 57.3%) and 15–20-year Treasuries (unchanged at 41.1%) to the 10-15 year at 1.6%. There’s also a slight deviation from the fund’s Bloomberg Long US Treasury Index benchmark, which, by comparison, has a larger 58.3% allocated to the 20-30 year, a relatively lower 39.8% to the 15-20 year, and a relatively higher 1.9% to the 10–15-year segment.

The result is a lower average maturity at 22.6 years, making the fund less sensitive to interest rate fluctuations (i.e., duration) than before. In return, SPTL still offers an attractive 4.8% yield to maturity – a premium to the 4.5-4.7% yield range of ten-to-thirty-year Treasury bonds currently. By comparison, TLT maintains a longer 25.6-year maturity profile (implying higher interest rate risk) but an equivalent 4.8% yield. The VGLT portfolio, on the other hand, has a similar average maturity (22.6 years) but gives up 40bps of yield (4.4%). Thus, relative to its key comparables, SPTL strikes the right balance between risk and reward, in my view.

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Source: State Street, iShares, Vanguard

SPTL Performance – No Escaping Treasury Headwinds

Treasuries, in general, have been underwhelming in recent years, and SPTL’s poor track record reflects this. The ETF is currently down -3.2% in NAV terms (-3.1% in market price terms) this year; performance only gets worse the more you zoom out, with the one and three-year annualized total return at -6.2% and -8.1%, respectively. Still, SPTL has delivered relative outperformance vs TLT and VGLT across virtually all timelines. And zooming all the way out to its inception in 2007, SPTL has also returned +3.6% annualized – even if much of this gain was achieved during a very different interest rate regime.

Whether we return to the ultra-low rates of the post-’08 era is anyone’s guess, though Fed estimates that long-run neutral rates are back on the decline support the view that rates need to be cut quite a bit. In theory, long-duration funds like SPTL should also gain significantly through a rate cut cycle due to their interest rate sensitivity. The problem, though, is that rate expectations are already quite low – the Fed’s dot plot already calls for a return to a 2.5% ‘terminal’ (i.e., long run) Fed Funds rate, which is about in line with Holston, Laubach, Williams’s 0.7% ex-inflation neutral rate estimate.

There’s also the anomalous supply/demand balance, to a large extent, caused by the Treasury issuing far more short-duration T-bills than the 15-20% recommended by the borrowing committee (or ‘TBAC’). More supply pushes yields higher, a key reason T-bills yield up to 5.4% today. The 10-30-year segment has, by comparison, been relatively untested by new issuances and, thus, hasn’t seen as much yield pressure. When supply returns to the longer end, though, expect the inverted yield curve to un-invert – to the detriment of longer-duration Treasury bond funds like SPTL. In this context, I don’t see a particularly compelling reason for exposure here.

Steer Clear of Treasury Bonds

It might seem tempting to lock in current multi-year high yields via longer-dated Treasury maturities. But for both fundamental and technical reasons, there are much better reasons to sit on the sidelines, in my view. Though SPTL does stand out among the major long duration funds for having the best balance of income and risk, higher-yielding T-bills remain a lot more interesting to me as long as the yield curve stays inverted.