U.S. government bonds ETFs act like bond mutual funds by tracking indexes composed of U.S. government obligations. Indexes can consist of nominal and U.S. Treasury inflation-protected securities, or TIPS. Nominal bonds pay a fixed interest rate, while TIPS pay an interest rate equal to the inflation rate plus a fixed premium. U.S. government ETFs are exempt from paying state and local taxes on the interest rate earned. They are also much safer compared to other fixed-income ETFs due to very low default risk. At the same time, they offer much lower returns compared to other riskier bonds.
Because the U.S. obligations market is highly liquid and does not entail high transaction costs, the expense ratio for the U.S. government ETFs tends to be very low. The performance of the U.S. government ETFs is closely tied to the projected interest rates, with rising rates causing the price of a bond ETF to fall.
iShares 1-3 Year Treasury Bond ETF
Started in 2002 by BlackRock Fund Advisors, the iShares 1-3 Year Treasury Bond ETF (SHY) seeks to track the performance of the Barclays U.S. 1-3 Year Treasury Bond Index, which is an index composed of U.S. obligations with maturities ranging between one to three years. SHY has an effective duration of 1.86 years and its holdings are 99% invested in U.S. Treasury instruments. SHY provides exposure to short-term U.S. Treasury bonds and targets a specific segment of the U.S. obligations market. The expense ratio of the fund is 0.15%, which is in line with comparable ETFs.
SHY is most suitable for investors looking for a substitute for a cash account and exposure to U.S. government bonds with very low risk of default and shorter durations.
The SPDR Barclays Intermediate Term Treasury ETF
The SPDR Barclays Intermediate Term Treasury ETF (ITE) was created by SPDR in 2007 to provide investment results that generally correspond to the performance of the Barclays Intermediate U.S. Treasury Index. ITE primarily invests in U.S Treasury notes and bonds with maturity ranging between one to 10 years, and the weighted average maturity of ITE is about four years. As of July 2015, the yield-to-maturity stands at 1.2%, and the expense ratio for the fund is 0.1%.
ITE is most suitable for investors looking for a safe haven investment in highly rated U.S. government bonds that have the intermediate term maturities.
Vanguard Long-Term Government Bond ETF
Vanguard started the Vanguard Long-Term Government Bond ETF (VGLT) in 2009 to track the performance of Barclays U.S. Long Government Float Adjusted Index, which includes nominal bonds and notes issued by the U.S. Treasury and U.S. government agencies with maturities greater than 10 years. As of July 2015, the fund invested 93% of its holdings into long-term nominal bonds issued by the U.S. Treasury and 5% of its holdings into U.S. agency debt. Due to a very low portfolio turnover ratio, the ETF has a low annual expense ratio of 0.12%. The current yield of the fund is 2.86%, and its average weighted maturity is 24.7 years. Because the fund invests in very long-term obligations, it is especially sensitive to the changes in market interest rates.
This ETF is most appropriate for investors who seek a high and sustainable level of current income through investing in U.S. government bonds with a very long dollar-weighted average maturity ranging between 10 to 25 years.
SPDR Barclays 0-5 Year TIPS ETF
The SPDR Barclays 0-5 Year TIPS ETF (SIPE) tracks the performance of the Barclays 0-5 Year U.S. Government Inflation-Linked Bond Index, which is principally composed of the TIPS with maturities up to five years. The fund provides real yields by investing in TIPS shielded from inflation that are expected to occur in the future. Because of inflation protection, TIPS offer lower returns in times of deflation and higher returns in times of inflation. The fund has an expense ratio of 0.15%, which is in line with similar fixed-income ETFs, and has an average weighted maturity of 1.3 years.
This fund is most suitable for investors who want to obtain protection of their returns from inflation and invest in highly rated fixed-income securities with medium-term maturity.