Treasury Bills: A Revaluation of the ‘Risk-Free’ Standard
Investing can seem complex, but at its core, it’s about identifying opportunities in the market for wealth creation without taking on unnecessary risk. One such opportunity that has recently gained attention is Treasury bills. In this article, we will explore why the legendary investor Warren Buffett holds $126 billion in short-term Treasury instruments, why ‘risk-free’ yields have surged, and how average investors can benefit from this development.
For those closely following the economic landscape, the US government is offering 3-month Treasury bills this week at a yield of 5.286%. Just two years ago, you would have received less than 1% return on a 3-month bill, meaning that what is generally considered a low-risk investment can now provide investors with more than a 5% gross return in 3 months. Let’s delve into the reasons behind this surge in yields.
Treasury bill yields are influenced by various economic factors. Firstly, the US government is grappling with an astonishing $33 trillion in debt, approximately 121% of the country’s GDP in 2022. This high debt level suggests a worsening fiscal situation, making investors wary of lending money. Additionally, inflation plays a significant role; as the government tightens monetary policy to combat high inflation, borrowing costs rise. This fiscal policy aims to slow down the economy but also contributes to increased Treasury yields.
While the above factors make it clear that Treasury bills are not entirely risk-free, they still rank as a relatively defensive asset class, considered less risky than equities and corporate bonds.
How Pricing Works
As with any bond, price and yield are inversely related. This means that if you hold a 3 month treasury bill at 5% and yields go up, the price of your bond will fall as investors can access higher yields elsewhere, forcing you to sell your bond at a cheaper price, giving the buyer more capital gain if held till maturity. The same works the other way around. If yields fall to 4.5% (economic outlook improves), then the price of your bond with a 5% yield will increase, as your product suddenly becomes more attractive.
Investors will make a return on the instrument through capital gain, either through sale on the secondary market or by holding the bill through to maturity. Treasury bills do not pay a coupon like other bonds due to their short-term nature (usually 1, 3, or 6 months). They are instead issued at a discount. For example, you might pay $950 for every $1,000 worth. At maturity, the government will pay back the full value. It is important to consider other factors that may affect the return, such as broker fees, foreign exchange, and other costs.
The Treasury bill is generally considered a product with relatively low risk, as you are lending to the US Government and not a corporation or some other institution. Investors usually consider T-bills as the ‘risk-free rate,’ meaning that this is the maximum return available while taking on minimal risk. Therefore, it helps us compare returns with other asset classes that may require the investor to take additional risk. So, going back to my introduction, in an equity market that has been in correction since late July, it comes as no surprise that investment managers such as Warren Buffett are increasing their allocation to short-term treasuries.
As with any investment, there are risks to consider. Firstly, interest rate risk, as I mentioned earlier, price and yield move against each other, so if you purchase a bond and obtainable yields rise, your investment becomes less valuable. Inflation risks must also be considered. If the general price of goods and services increases, this has a negative effect on the returns from a Treasury bill. However, seeing as Treasury bills are short-term cash instruments, the investor is not exposed to this risk for a long period of time, and therefore, this may be more applicable for someone who is purchasing a bond with a longer term to maturity.
How European Investors Buy US Treasury Bills
European investors can acquire US Treasury bills through various means. Specific accounts designed for Treasury bill purchases are available, but using a broker is often a more accessible and safer option for the average investor. Broker-assisted transactions not only offer security but also provide better liquidity if you intend to sell your bills on the secondary market.
For more diversification and skilled management, consider accessing Treasury bills through funds. This approach not only ensures expert oversight but also offers improved liquidity. You can get in touch with one of our Client Executives at Framont & Partners Management to better understand how you can access these investment products.
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