3 Long-Duration Treasury ETFs to Watch if Rates Fall

Key Points

• Long-duration Treasury bond ETFs may offer contrarian upside if inflation eases and interest rates decline from elevated levels.
• TLT provides the most liquid and straightforward access to 20-plus-year Treasuries, with over $40 billion in assets and a 4.55% dividend yield.
• EDV offers a lower expense ratio of 0.05% and greater diversification than ZROZ, though it carries a slightly lower dividend yield of 4.97%.

Long-duration U.S. Treasury bonds have had a tough time amid inflation, interest rate activity, and yields that have risen dramatically since a pandemic-era low point. While the consensus view may be that long bonds like this are risky, contrarian investors can argue that long-duration Treasury bond exchange-traded funds (ETFs) may offer asymmetric upside if inflation fears diminish and rates normalize once again.

Oil prices may be an important driver here, as oil price spikes may be prolonging sticky inflation. A reduction of geopolitical risk—say, via a ceasefire between the United States and Iran—may drop both inflation expectations and Treasury yields. Because even a modest drop in long-term yields can significantly impact the performance of long-duration bonds, investors anticipating such a shift may want to get in now.

A Highly Liquid Option for Straightforward Long-Duration Treasury Access

The iShares 20+ Year Treasury Bond ETF NASDAQ: TLT is a highly liquid long-duration bond trade that may appeal to investors seeking to draw out the duration of their portfolio. The fund has more than $40 billion in invested assets and a one-month average trading volume of just under 27 million.

As the name suggests, TLT focuses on Treasury bonds with remaining durations greater than 20 years. This extended duration leaves these bonds open to interest rate risk, which may make long-duration bonds less likely to figure prominently in some broader bond funds. For this reason, a fund like TLT can be a useful way to gain exposure to this specific asset class.

TLT's portfolio comprises about 50 distinct Treasury bond positions, and the fund pays a dividend yield of 4.55%. If yields do decline, TLT may experience meaningful upside while remaining less volatile than duration-sensitive alternatives. In terms of overall liquidity, ease of access, and simplicity of strategy, TLT can be a great option for investors seeking to broaden their Treasury exposure.

A STRIPS Approach With High Interest Rate Impact

For a slightly different approach, the PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF NYSEARCA: ZROZ tracks an index of STRIPS, bonds with the interest payments removed and sold separately, leaving just the principal payments made at maturity. Specifically, ZROZ focuses on STRIPS for bonds with at least 25 years remaining until maturity.

With an ultra-long-duration strategy like this, interest rate movements are especially impactful. When rates fall, the fund is likely to do quite well—this makes ZROZ a good candidate for investors expecting that rates might come down after an extended period of elevation.

The unique approach ZROZ takes makes it significantly more niche than TLT above, and the fund's asset base of just $1.3 billion and modest trading volume (a one-month average of just over half a million) reflect this. ZROZ is therefore not the most liquid long-duration bond fund, and investors seeking more active trading should beware. Still, its dividend yield of 5.08% is quite attractive, and ZROZ matches TLT's expense ratio of 0.15% exactly.

An Alternative to ZROZ With Lower Fees and Higher Liquidity, But a Yield Trade-Off

The Vanguard Extended Duration Treasury ETF NYSEARCA: EDV adopts a similar approach to ZROZ in that it focuses on long-duration STRIPS with maturities between 20 and 30 years out. For access to strong credit quality, EDV may be a great choice for investors seeking that protection. Of course, like ZROZ, EDV does carry a higher level of interest rate risk than some other bond fund options.

Investors expecting that the Fed will hold rates steady or make cuts in the future might reasonably also expect EDV to provide attractive returns, given its yield advantage over shorter-term Treasury investments. One important distinction between EDV and ZROZ is the former's major fee advantage: EDV's expense ratio of 0.05% is just a third of its rival's. It also has a higher asset base of about $3.5 billion and more robust trading volume.

With a broader portfolio of more than 80 positions, EDV is also more diversified than ZROZ. Where the fund does miss out slightly compared to its competitor, however, is in dividend yield. EDV's yield is slightly lower at 4.97%. Still, giving up a bit of potential yield in favor of greater liquidity, a more diversified basket, and a substantially lower fee may make EDV the STRIPS fund of choice for many investors bullish on long-term Treasury prospects more broadly.