Vanguard Short-Term Treasury Fund

Short-term Treasury Funds Also Have Risks

Backed by the full faith and credit of the United States---which means Uncle Sam isn't expected to welch on making timely interest and principal payments on its debt securities--- Treasury bills, bonds and notes have garnered trust from the investing public.

In the mutual fund arena, funds investing in short maturing Treasuries have been particularly popular over the past few years because of their credit history and the positive impact a falling interest rate environment has had on their performance.

The Vanguard Short-Term Treasury Fund (800-523-1154) has been one of the top performing short-term fixed-income funds over the past three-, five- and 10-year periods, according to Lipper.With an average annual total return of 8.17 percent over the past three years, ending June 5, 2003, the fund has rewarded its shareholders handsomely during the bear market on equities.

David Glocke has been the fund's portfolio manager since 2001. And, while interest rates have dropped, nearly all of the fund's assets are currently invested with 90 percent invested in pure US Treasuries.

" If you think that the Fed is going to lower rates, you make money being invested," Glocke says.

Here's more from Glocke about the Vanguard Short-Term Treasury Fund, (VFISX):

Q: What kind of investor is the Vanguard Short-Term Treasury fund ideally suited for?

A:Those who want to be exposed to the fixed-income market yet may not be comfortable with corporate securities. This fund has at least 80 percent (of its assets) invested in US Treasury securities all the time. So, it offers a significant advantage to those who are a little more risk- averse but who also want to have a fixed income exposure. It's also been popular for investors who have had a view on the economy believing that short-term interest rates who drop.

Q: Can you tell me more about that?

A: As interest rates decline, prices rise and short-term fixed-income securities' performances will be more greatly impacted by changes in the economy and Fed policy than long-term securities are. That's because long-term fixed-income securities are more influenced by issues like inflation and the overall general market place.

Q: Over the past few months, Vanguard has been out in front warning investors that one day interest rates are going to turn around and start moving upward. And, not to put all of their investment dollars into fixed-income. When rates do turn, what will that mean to the fixed income investor?

A: We've seen Fed Fund rates ( the interest rates charges by banks for overnight loans) fall from 6.5 percent to 1.25 percent and the market is speculating now that it is going to drop even further. So, as those short-term interest rates come down, Vanguard has taken the position to let investors know that there is a risk in being invested only in a short-term (fixed-income) portfolio.

Investors chasing yield has been pretty commonplace and when the market starts to anticipate that rates are going to go up, they will probably go up quickly.

Q: Does that mean a short-term Treasury fund like this will be a bad investment when rates do start to increase?

A:What's going on in the marketplace right now is really an education for a lot of investors. For a long time everybody was focused on equities. I'd go to a party and meet friends and all they would want to talk about is some dot-com company that didn't even have a Web site yet. And I'd keep trying to tell them to diversify their portfolios. But, a lot of them traded on past performance. Right now we're seeing the same kind of thing---investors chasing returns in fixed-income securities.

Q: So, just like those who got in at the end of the bull market in stocks, they could get burned too, only this time from fixed-income?

A: Exactly. Investors shouldn't chase returns. They should have a long-term outlook, not a short-term one. And as rates decline and get to historic low levels, that ought to make investors more sensitive to the issue (that one day rates will rise again).

Regarding the fund, whether it is a good investment or not depends upon what your investment goals and needs are. This fund offers great exposure for those who need short-term Treasury exposure in their portfolios. For people who want to move out on the yield curve and stay invested in Treasuries, Vanguard offers an immediate, as well as long-term Treasury fund.

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Dian Vujovich is a nationally syndicated mutual fund columnist, author of a number of books including Straight Talk About Mutual Funds (McGraw-Hill), and publisher of this web site.