EDV: Long Term Bonds for Portfolio Diversification with the S&P 500 at Record High

This ETF which provides exposure to long-term bonds has been moving in opposite sides to the SPDR S&P 500 ETF (SPY) which delivered a 148.4% performance during the last five years. In relative terms, EDV delivered a meager 9.97% gain.

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Source: tradingview.com

Looking into the reason for this underperformance, there is the yield of the 10-year U.S. Treasury note which rose by more than 1% from August 2020 through late March 2021. Now, as bond prices fall with rising rates, EDV’s share price started falling as shown by the blue dotted marker starting on August 3, 2020 (above chart). Pursuing further, the brown marker (dotted line at March 21) marks the end of EDV’s downtrend coinciding with the end in the rise of the treasury yields.

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Source: advisors.vanguard.com

Just one year earlier, or in March 2020, EDV’s investment-grade bonds performed well during the market crash, while the S&P 500 suffered for a longer period as shown by the orange chart dipping by nearly 50% before recovering only six months later. Getting further support from Vanguard Research for January through March 2020, this period marked a height in volatility for equities due to the COVID-19 pandemic, with investment-grade bonds worldwide returning just over 1% while equities fell by almost 16% globally.

This outperformance of bonds was again noted during the global financial crisis (2008-2009) when stocks sank by an average of 34% while the market for investment-grade bonds returned more than 8%. The same was noted for several other market cycles from January 1988 through November 2020, which showed that whenever equity returns were down, bonds remained positive for most of the time.

Such uncorrelated returns between equities on the one hand and investment-grade bonds on the other demonstrate the diversification benefits of an asset-class level diversification can offer investors, especially at times of acute market turbulence. In this case, it is a balanced portfolio in stocks and bonds. Consequently, the temporary “volatility” seen in the performance of bonds as a result of changes in interest rates from August 2020 to May 2021 should not constitute an excuse for a strategic change in the allocation of fixed income versus equities in your portfolio.

In this case, just like equities, there are near-term risks in owning bonds, but, for the long-term, as seen by EDV’s five-year performance of nearly 10%, one can still stick to a time-tested formula like government bonds.

My point here is to hold bonds as a part of your portfolio, aiming for a 60:40 asset allocation in favor of equities. For this purpose, there are other long-term bonds ETF like the iShares 20+ Year Treasury Bond ETF (TLT), but I prefer the Vanguard ETF as at $140, it remains far from its high of $175, thus available at a relative bargain. Additionally, it pays quarterly dividends with a higher yield of 1.94%, compared to 1.49% for TLT. EDV also has a lower expense ratio of only 0.06% as shown in the table below.

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Source: investor.vanguard.com

Finally, unlike equity investing, investment-grade bonds must be considered as a longer-term investment. For this matter, EDV seeks to track the performance of the Bloomberg U.S. Treasury STRIPS 20–30 Year Equal Par Bond Index, which is passively managed using index sampling. The index provides fixed income with high credit quality.