Vanguard Short-Term Treasury ETF is Cost-Efficient and Compelling

Vanguard Short-Term Treasury Index VGSH provides a market-value-weighted portfolio of short-term Treasury bonds. Its cost-efficient approach and razor-thin expense ratio make this a compelling option.

The strategy tracks the Bloomberg 1-3 Year U.S. Treasury Index, a market-value weighted portfolio of U.S. Treasury bonds with one to three years remaining to maturity. Market-value weighting is a sensible approach in the liquid U.S. Treasury market as it harnesses the market’s collective wisdom about the relative value of each bond. However, the issuing activity of the U.S. Treasury Department will play a large role in determining the composition of the portfolio.

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. 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.

Credit risk is virtually nonexistent since each Treasury holding is backed by the full faith and credit of the U.S. government. This provides investors a place of refuge when credit markets sour. With less risk comes less reward, though, and this fund can leave yield on the table by not reaching for riskier bonds. During stable interest-rate environments, this fund’s SEC yield tends to lag that of the typical peer. However, during periods of rising rates, like in 2022 and 2023, its yield can outrun most competitors’. The fund’s SEC yield stood at 4.78% compared with the typical peer’s 4.52% yield as of June 2023.

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 U.S. Treasury yield curve. The fund will lose value when interest rates rise. But the effect will be muted because it has a lower duration than most peers. Indeed, the fund fared more than a percentage point better than its typical short-government peer in the inflationary environment of 2022.