iShares 7-10 Year Treasury Bond ETF (IEF): On A Downward Rally

The U.S. economy has been strongly impacted by the COVID-19 pandemic, supply chain disruption, and the energy crisis due to war in Ukraine. On top of that, as inflation reached a 40-year high and the Federal Reserve hiked interest rates, the bond exchange traded funds started struggling. Price of iShares 7-10 Year Treasury Bond ETF (NASDAQ:IEF), a portfolio of various United States treasury notes, has dropped by almost 14 percent since 1st March. IEF’s price crossed the bottom low of the past 10 years, and is expected to drop further. However, the attractive premiums available in short term put options make it an interesting fund to play with.

About iShares 7-10 Year Treasury Bond ETF

iShares 7-10 Year Treasury Bond ETF is an exchange traded fund (“ETF”) launched by BlackRock, Inc. and managed by BlackRock Fund Advisors. IEF seeks to track the performance of the ICE U.S. Treasury 7-10 Year Bond Index, by using representative sampling techniques. As the name suggests, both the benchmark index and IEF invests in U.S. dollar denominated fixed rate treasury securities with remaining maturity of minimum 7 years and maximum 10 years. As IEF’s portfolio consists of treasury notes only, all the investments are on AAA rated securities, meaning zero chances of default.

IEF was formed on July 22, 2002 and has been consistently paying monthly dividends since then. But the yield has been low. During the past decade, average yield ranged mostly between 1 percent to 2 percent. Since 2021 the yield fell below 1 percent. That’s not surprising because the weighted coupon earned on the portfolio is 1.36 percent. However, there is a real cause of concern that the dividend has had a negative growth over the past 10 years.

The fund has an asset under management (AUM) of 17.4 billion, and has a low expense ratio of 0.15 percent. The portfolio has an effective duration of 8.04 and a yield to maturity (YTM) of 2.36. Effective duration calculates the expected price decline of a bond when interest rates rise by 1%. YTM on the other hand is the estimated total return anticipated from a bond if the bond is held till the date of its maturity. That total return is then divided by the number of years left till maturity, and this annualized rate of return is treated as the internal rate of return (IRR) of that bond.

Historical Performance

Equity shares and bonds have an inverse relationship. When the stock market performs poorly, investors invest more in bonds to earn a safer return. On the other hand, when the stock market is on a bull run, investors invest more in equity shares, expecting higher returns. The price of IEF rose during the first quarter of 2020, as the stock market crashed due to the pandemic.

With respect to price, this treasury bond fund performed relatively well during 2020 and 2021. The stock traded at a price higher than $115 for the entire period. But as the stock market started recovering, the bond fund was expected to make a price loss. As a result of this, in February 2022, this fund was trading at a price almost similar to that of February 2020.

What Lies Ahead?

However, there is a huge drop of 14 percent during the past 15 weeks. Price dropped from $113.5 on 1st March to $98.15 on 14th June. The price is expected to further drop down, if we monitor the indicator of simple moving averages ((SMAs)) 200 days SMA (110.86), 100 days SMA (106.66), 50 days SMA (102.93) and 10 days SMA (101.28) clearly indicate a downward rally. This is significant, because during the past 10 years, the bond’s price never fell below $99, and here we are expecting it to stay below this price for quite a long time.

The year 2022 has been particularly bad for bond funds due to several reasons, like soaring energy prices, rising consumer prices, prospect of less-accommodative monetary policy, hike in short term interest rates, Russia’s invasion of Ukraine, etc. Most funds lost significant value during this period. Funds like Schwab U.S. Aggregate Bond ETF (SCHZ), iShares Core U.S. Aggregate Bond ETF (AGG), IEF, and Vanguard Total Bond Market ETF (BND) lost almost 10 percent of their value in 2022.

Price of iShares 20+ Year Treasury Bond ETF (TLT) dropped by almost 20 percent. Price of two other BlackRock, Inc.’s funds, iShares 3-7 Year Treasury Bond ETF (IEI) fell by 6.6 percent, while that of iShares Core U.S. Treasury Bond ETF (GOVT) fell by 8.6 percent. Historically, in a bearish market, longer-term bonds get more impacted than the short-term bonds. IEF falls in between, as its effective maturity is 8.6 years.

However, all is not lost for bond ETFs like IEF. There must be investors waiting for these funds to reach a bottom in order to buy in bulk. As discussed earlier, the price has breached 10-year lows and is expected to fall further. Because this fund is composed of zero default treasury notes, investors will pour in funds, as the stock market is also in a bearish phase. Also, fund managers with specified allocation ratio of stocks and bonds have to rebuild their fixed-income portfolio before the end of this quarter. All these will potentially increase the investments in bond ETFs.

Hopefully, IEF’s price will not fall drastically. I don’t expect a further price loss beyond 6 percent, i.e., 20 percent drop since March 1st. But even for a loss of 2 to 3 percent, this fund will be quite interesting to play with. A three percent loss will bring the price close to $95. Since short term options of June and July 2022 (up to one month forward) put options of $100 are available at a low premium (within a range of $1.15 and $1.95), investors can gamble with this fund. They can buy a $100 put option, wait for the fund to fall further, and buy on that price so as to gain through exercising the put option.