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All the talk about cash on the sidelines – there’s a record amount of cash in money market funds and it’s well over $6 trillion – is about to collide with rampant speculation that the Federal Reserve will soon lower interest rates.
Of course, lower interest rates diminish the appeal of cash because yields on cash instruments are correlated to Treasury yields. Cash conversations are increasingly pertinent because assuming the Fed lowers rates this month by just 25 basis points – the hope is that it will be 50 basis points – it’s widely believed that will touch off an easing cycle that could see rates fall 150 basis points by the second quarter of 2025.
Obviously, that means lower yields are on the way for CDs and money markets, but that doesn’t imply that the utility of cash is about to die. While Fed easing cycles have historically been efficacious for risk assets, there are no guarantees that history will repeat and with a presidential election looming, equity market volatility could increase. That implies keeping some dry powder remains a valid consideration for a broad swath of clients.
For advisors seeking inexpensive, straight-forward cash solutions for clients, the world of exchange traded funds has plenty of options, including the Vanguard Short-Term Treasury ETF (VGSH). Let’s explore some of the fund’s perks here.
VGSH Resume
VGSH follows the Bloomberg 1-3 Year US Treasury Index, meaning it holds Treasurys with maturities of one to three years. So not only is VGSH is easy to understand, credit risk isn’t a consideration with this ETF. Its status as a passive ETF is relevant because it’s difficult for active managers to outperform in the Treasury market.
“The Treasury market is highly efficient and liquid, reflecting the market’s inflation and interest-rate expectations. It is difficult for active managers to gain a durable edge and recoup their fees in this market without also taking greater risk than this portfolio,” notes Morningstar analyst Zachary Evens. “An ultralow-risk fund charging mere basis points, like this one, presents a high hurdle for any active manager in the Morningstar Category to outperform.”
As noted above, credit risk isn’t a consideration with VGSH, but to an extent, there is interest rate risk. However, this is a short-term ETF, so it’s not highly sensitive to rising or falling interest rates.
“Interest-rate risk is the only risk the portfolio is exposed to, but even that is kept under wraps by focusing on the short end of the US Treasury yield curve,” adds Evens. “The fund will lose value when interest rates rise. But the effect will be muted because it has a lower duration than most peers.”
Speaking of Performance…
VGSH is by no means exotic. In fact, it’s quite basic and that might elicit concerns about its performance potential, but the ETF’s long-term track record measured against its peer group is solid.
As is par for the course with so many Vanguard ETFs, VGSH’s durability over long holding periods is helped in part by its low fee. The fund charges just 0.04% per year compared to an average of 0.60% for rival funds.
“The exchange-traded fund generated solid risk-adjusted performance from its inception in November 2009 through August 2024,” concludes Evens. “Over that span, it outperformed the category average by 14 basis points annualized, with lower volatility. Lower interest-rate and credit risk helped insulate the portfolio from the sometimes-volatile movements of longer-duration or lower-quality peers.”
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