A Compelling Case for This Vanguard ETF as an Excellent Cash Substitute

Key Morningstar Metrics for Vanguard Short-Term Treasury ETF

Morningstar Medalist Rating: Gold
Process Pillar: Above Average
People Pillar: Above Average
Parent Pillar: High

Vanguard Short-Term Treasury Index VGSH provides a market-value-weighted portfolio of short-term Treasury bonds. Its cost-efficient approach and razor-thin expense ratio make this a compelling option.

The fund tracks the Bloomberg 1-3 Year US Treasury Index, a market-value-weighted portfolio of US Treasury bonds with one to three years remaining to maturity. Market-value-weighting is a sensible approach in the liquid US Treasury market as it harnesses the market’s collective wisdom about the relative value of each bond. However, the issuing activity of the US Treasury Department will play a large role in determining the composition of the portfolio.

The Treasury market is highly efficient and liquid, reflecting the market’s inflation and interest-rate expectations. It is difficult for active managers to gain a durable edge and recoup their fees in this market without also taking greater risk than this portfolio. An ultralow-risk fund charging mere basis points, like this one, presents a high hurdle for any active manager in the Morningstar Category to outperform.

Credit risk is virtually nonexistent since each Treasury holding is backed by the full faith and credit of the US government. This provides investors a place of refuge when credit markets sour. With less risk comes less reward, though, and this fund can leave yield on the table by not reaching for riskier bonds. During stable interest-rate environments, this fund’s SEC yield tends to lag that of the typical peer. However, during periods of rising rates, like in 2022 and 2023, its yield can outrun most competitors’.

Interest-rate risk is the only risk the portfolio is exposed to, but even that is kept under wraps by focusing on the short end of the US Treasury yield curve. The fund will lose value when interest rates rise. But the effect will be muted because it has a lower duration than most peers. Indeed, the fund fared more than a percentage point better than its typical short-government peer in the inflationary environment of 2022.

Vanguard Short-Term Treasury ETF: Performance Highlights

The exchange-traded fund generated solid risk-adjusted performance from its inception in November 2009 through August 2024. Over that span, it outperformed the category average by 14 basis points annualized, with lower volatility. Lower interest-rate and credit risk helped insulate the portfolio from the sometimes-volatile movements of longer-duration or lower-quality peers.

When interest rates rise, this fund will lose value. A shorter average effective duration than most short-government category peers minimizes this negative effect, though. This fund outperformed its typical peer by more than a percentage point in the rising-rate environment of 2022. However, it still lost about 4% of its value that year.

This fund’s conservative profile can leave it well behind its peers when the market rewards credit risk, interest-rate risk, or both. But with a razor-thin expense ratio, the fund is well-positioned to overcome those obstacles and maintain a long-term advantage.

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