A Surprisingly Effective Safe-Haven ETF

 | Jun 05, 2012 | 2:00 PM EDT  | Comments
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EDV

As a number of my Real Money colleagues have been discussing lately, May was a brutal moth for most investors. As risky asset prices declined, many investors and traders recorded huge losses. But for those with exposure to effective safe havens, May wasn't actually that bad.

Nothing eases the pain during a tough month quite like a bond ETF that jumps 14% while stocks slide. That eye-popping return can erase a lot of pain from big dips in domestic and international stock positions, and potentially leave investors better off than they were when the month began. Imagine being thrilled with your returns over the past five weeks. Believe it or not, that monthly gain was posted not by a risk-heavy, leveraged, and inverse exchange-traded fund, but by a relatively plain vanilla bond fund. The Vanguard Extended Duration Treasury ETF (EDV) jumped 14.1% in May, thriving as investors fled equities and sought out calmer harbors to ride out the storm.

This should serve as a reminder to investors: Despite the general hesitance to establish positions in long-term bonds, this asset class remains one of the most effective hedges against bear markets. When stocks falter, the appeal of long-term Treasuries spikes and prices tend to climb much higher.

Over the past few years, we've heard more than a few calls for a bubble in bond markets. In fact, the first predictions of doom and gloom in fixed income markets came as soon as the recovery from the (first) recession began. Widely followed and well-respected money managers were warning clients to abandon fixed income -- especially those securities with long durations.

Concerns over long-term debt have some basis in compelling fact. Because bond prices tend to decline when interest rates rise, investors have been concerned that the current market environment -- where interest rates are hovering at near-zero levels -- is less than ideal for fixed income. Rates can't go much lower, and they will inevitably have to start rising as inflationary pressures materialize. When (not if) that happens, long-term bonds will likely see a meaningful decline in value.

But if you think a rate-hike campaign is coming , I have some real estate in Florida I'd like to talk to you about. The Federal Reserve has been transparent about its intentions to keep interest rates depressed for this year and most of next, and the events of the past few weeks will likely extend that timeline. For those with a five-year time horizon, long-term bond ETFs such as EDV might not make much sense. But for those looking to establish an effective hedge against further stock market declines, this corner of the fixed-income market might be worth a closer look.

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