For some time now, you have likely heard us talk about our Portfolio Managers’ (PM) affinity for the 20-year spot on the yield curve. This year, however, you may have noticed that longer maturities have been a drag on performance year-to-date. Despite this volatility, we remain convinced in the value offered by the 20-year Treasury; in fact, we have continued adding to the position. In this article, we explain why.
There are two key reasons behind our conviction. The first is the power of higher starting income, which our Client Portfolio Manager, Taylor Huffman, covered in the June installment of “Shape of the Markets.” The second is how attractive the 20-year Treasury looks today, relative to everything else in the fixed income market.
As a quick recap on the power of starting income: in August 2021, it would have taken only a small increase in rates to move the 20-year Treasury into negative territory1. Today, rates on the 20-year Treasury would need to rise by over 180 basis points (bps) over three years before this bond faces a negative annualized return2. This is why you’ll hear us say, “the higher rates go, the safer bonds get.” On the flip side, if rates fall by roughly 100 bps over the next three years, the 20-year Treasury’s Annual Return would equal the 20-year historic average of the S&P 500 Index3 (9.24%)! As a stand-alone investment, the 20-year Treasury has an attractive, go-forward return profile.
Three-year horizon total return analysis (Illustrative performance)
Change in Interest Rates (Basis Points)
Sources: PTAM, Bloomberg. The 20-Year Treasury is constructed with the on-the-run 20-Year Treasury, but broadly speaking, could be a Treasury with a tenor between 15 and 25 years. These total returns are estimated over a 3-year horizon. The following bonds that are used to create the Shapes are held by PTAM clients as of the date of this presentation: 20-year Treasury.
Assumptions: (1) a parallel shift in the yield curve (2) static allocation for 3 years (3) linear rate changes (4) sector specific spreads are held constant across five rate scenarios (5) reinvestment rate consistent with respective sector.
High levels of starting income are important, but they don’t capture the whole story. For example, in October of 2023, the yield on a 20-year Treasury was higher than it is now; however, the 20-year Treasury is a better choice for portfolios today than it was in 2023. Why does this sector make more sense for investors now?
1) Slope- If we look at the differences between the 2023 yield curve and today’s curve, we can see that the overall steepness of today’s yield curve is greater than it was in 2023. Back then, the level of compensation received for shorter-term Treasuries rivaled that of the 20-year Treasury. The break-even between shorter and longer bonds was far less attractive than it is today, and this is why, in 2023, we held a larger proportion of “Defensive” sectors, relative to our “Offense.” Over the last three years, the short end of the yield curve has fallen over 150 bps. This significantly changes the relative value equation between long and short bonds. For example, on October 19th of 2023, when the 20-year
Treasury offered a 5.34% yield, the 3-year horizon, rates-unchanged scenario, total return was 5.59%4 for the 20-year Treasury, and 5.52%4 for the 1-year Treasury. In 2023, only 7 bps of total return separated the 1- and 20-year Treasury. Today, the 20-year Treasury offers a 3-year horizon, rates- unchanged total return of 5.82%5, while the 1-year Treasury only offers 4.00%5; that’s over 180 bps of additional return today. Past performance is not indicative of future results.
Three-year horizon total return analysis (Illustrative performance)
Source: Bloomberg.
2) Spread- If we observe Credit Spreads in October of 2023, both in the Investment Grade (IG) and High Yield (HY) space, investors were being better compensated for credit risk than they are today. On October 19th, when the 20-Year Treasury hit a 5.34% yield, the IG Corporate Option Adjusted Spreads (OAS) Index was at 129 bps6, and the HY Corporate OAS Index was at 423 bps7. In contrast, outside of a few sectors of the market (Commercial Mortgage-Backed Securities and certain Taxable Munis), spreads today are at historically tight levels, with IG and HY Corporate OAS Indices at 78 bps6 and 279 bps7, respectively. When bonds with a credit-risk component experience spread compression, their go- forward return profiles look less attractive, relative to bonds without credit risk. Our senior PM, Mike Plaiss, says it best, “when spreads are tight, Treasuries are cheap.”
What separates the 20-year Treasury of today from the 20-year Treasury of 2023 is its superior relative value when compared to the rest of today’s Fixed Income market. Even so, the 20-year Treasury being more attractive than it has been in over 20 years doesn’t mean it’s the only thing we are buying: given the volatility that comes with longer maturities, we continue to pair longer, low-credit-risk bonds like the 20-year Treasury with shorter bonds where we can take on a bit more credit risk. In this way, we continue to maintain a balanced profile regarding interest rate sensitivity, while simultaneously freeing ourselves to invest in the spots of the curve that offer the most value today.
It should be noted that this strategy is nothing new to PTAM, nor are its benefits. It has contributed to long-term outperformance for our strategies across multiple market environments, with uncertainty and volatility throughout them all. As time passes, short term volatility is moderated, and eventually overcome, when you invest with discipline in assets that win more often than they lose.
1- 20-year Treasury shape as of 8.2.21
2- 20-year Treasury shape as of 7.31.26
3- SPX Index | Historical Returns run in Bloomberg TRA screen, 7.31.06 – 7.31.26
4- 20- and 1-year Treasury shapes as of 10.19.23
5- 20- and 1-year Treasury shapes as of 7.31.26
6- LUACOAS Index – spread data taken from Bloomberg, 10.19.23 – 7.31.26
7- LF98OAS Index – spread data taken from Bloomberg, 10.19.23 – 7.31.26
Adam is a Client Portfolio Manager with 9 years of experience in fixed income markets. He serves as a liaison between the investment, marketing, and sales teams, leading investment strategy updates, portfolio communications, and market commentary. A previous employee of PTAM’s affiliate company, Performance Trust Capital Partners, Adam specializes in educating investors on complex fixed income asset classes and strategies through the lens of Shape Management. He holds a BA in Business Economics from Wheaton College.
Glossary
Yield Curve refers to the U.S. Treasury yield curve rates.Risks and Other Important Considerations
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