In the United States, a treasury ETF is a investment vehicle whose value is determined by its market price and is tied to the performance of various US Treasury bonds. These bonds are loans given out by investors to the government to raise money for public projects. A treasury ETF pools money from all of the fund investors and chooses certain treasury-issued securities that it believes will rise in value. By choosing this type of fund, an investor can get excellent portfolio diversification and gain capital growth from a relatively stable investment, although the value of bond funds can be affected by rising interest rates and inflation.
Any institution that issues a bond uses the funds of investors to raise money. When the issuer is the United States government, an investor can feel relatively safe that the bond principal will be repaid along with all regular interest payments. Mutual funds that specify in bonds are effective but require substantial capital investment. On the other hand, a treasury ETF is a flexible and affordable way for an average investor to get exposure to government bonds.
It is important to note that a treasury ETF derives its value from the action of investors. Whereas mutual bond funds are valued at the price of the net value of all of the bonds included, exchange-traded funds are traded just like stocks. Therefore, if a significant portion of investors are purchasing a specific ETF devoted to Treasury bonds, its price will go up. Its price will fall if there are more sellers than buyers.
This allows savvy investors to take advantage of a treasury ETF that might be undervalued. The best way they can judge this is by anticipating interest rates. If interest rates are lowered, the value of bonds already held by investors rises, since the interest rates for those bonds have already been set. Higher interest rates conversely decrease the resale value of bonds already held by investors.
While a treasury ETF is generally a safe and costly way for investors to manage portfolio diversification into the bond market, there are other factors to be considered. Fees attached to both the fund management and the brokerage firm in charge of buying and selling the ETF on the market can cut into an investor's profit margin. In addition, high inflation levels usually mean that bonds are earning less than what rising prices demand. Since an ETF allows for practices like short selling, which essentially bets against the good performance of a specific fund, investors can use this flexibility to benefit from treasury bonds even their value is dwindling.