Gurus Blast US Treasurys As Bad Investments

Experts are blasting US Treasurys as bad investments because of their limited upside potential and serious downside risk.

James Grant, editor of Grant's Interest Rate Observer, told Bloomberg News on Tuesday that Treasurys are a desert of value, pointing out that if the 10-year Treasury yields are just slightly above 2 percent, it will be better for investors to stay in cash, which is safer and more flexible.

Jeffrey Gundlach, CEO of asset management firm DoubleLine Capital, echoed this sentiment, stating in a January conference call with clients that investors should keep money in a coffee can instead of investing in Treasurys with maturities less than five years.

Yields on Treasurys are indeed low.

The latest data from the Treasury Department shows 30-year Treasurys yielding at 3.43 percent, 10-Year Treasurys yielding 2.29 percent, five-year Treasurys yielding 1.13 percent and 1-Year Treasurys yielding at 0.21 percent.

Treasury yields have relentlessly fallen since the global financial crisis, when the Federal Reserve cut short-term interest rates to near zero and bought huge quantities of U.S. Treasurys in the open market.

In 2011, however, they performed well because of capital gains, returning nearly 10 percent, according to Bank of America Merrill Lynch's benchmark index. Investors flocked to Treasurys amid global economic concerns, including fears from the European debt crisis.

The capital gains on Treasurys, however, are limited in 2012 because yields, which go down when Treasury prices go up, are now near zero.

There is no margin, no air underneath those bond yields and therefore limited, if any, price appreciation, Bill Gross, investment co-chief at Pacific Investment Management Co., or Pimco, wrote in a February commentary.

For example, yields on the 10-year Treasury are currently at 2.29 percent, which means the upside capital appreciation is limited to the 2.29 percent going to zero (a highly unlikely scenario).

The downside potential, however, is enormous, as yields can surge much higher, judging by historic levels. The record high for 10-year Treasury yields, for example, is 15.84 percent.

Yields may climb from current levels if more investors become concerned about long-term inflation in the United States.

Some of the smartest investors in the world have already positioned themselves for this possibility.

Back in 2010, Seth Klarman of Baupost Group, a fund that manages $24 billion, said he bought put options on long-term Treasurys that would pay off enormously if their price fell.

Yields could also go up if the U.S. economy were to improve, which may prompt investors to move away from Treasurys to riskier assets like stocks.

What incentives do investment managers or even individual investors have to take price risk with a five-, 10- or 30-year Treasury when there are multiples of downside price risk compared to appreciation? wrote Gross.