With few places to put money, Korean retail investors turn to ultra-short US Treasuries

As a global interest rate shock sends stocks and bonds falling in tandem, smart money is flowing into ultra-short US Treasuries. With rising rates pushing down even long-term bond prices, investors are treating securities maturing in three months or less as a safe harbor — holding what amounts to "cash better than cash" while they wait for the right moment to deploy capital.

South Korean retail investors net-purchased $218.49 million worth of the iShares 0-3 Month Treasury Bond ETF (ticker: SGOV) over the past month, according to the Korea Securities Depository. Last week, SGOV topped the weekly net-purchase rankings for overseas stocks among domestic investors, overtaking Meta, Alphabet and VOO, the S&P 500-tracking ETF.

The shift marks a sharp contrast with the first week of last month, when Korean retail investors poured money into AI-related names — Amazon ($176.2 million), SanDisk ($161.43 million) and Micron ($111.1 million).

The rush into ultra-short bonds reflects a steep climb in market interest rates. With stocks and long-term bonds falling together, investors are gravitating toward instruments that limit price volatility.

The yield on the 10-year US Treasury note rose 6 basis points (1 bp = 0.01 percentage point) during trading Tuesday to 5.026%, according to Bloomberg, breaching the psychologically significant 5% threshold and reaching its highest level since July 2007.

Equity markets are also under pressure. The S&P 500 and the Nasdaq 100 have fallen 2.57 percent and 3.69 percent, respectively, over the past month, according to Investing.com. The Philadelphia Semiconductor Index has dropped 10 percent.

Higher interest rates raise borrowing costs for companies. When rates climb, firms must pay more interest on new debt, and loans taken out at lower rates must be refinanced at higher ones when they mature. The heavier interest burden squeezes profits and leaves less capital for equipment investment and business expansion.

Rising rates also affect the yardstick used to value stocks. A higher discount rate reduces the present value of a company's future earnings, meaning the same profit forecast translates into a lower assessed valuation. That is why technology stocks — whose share prices heavily reflect expectations of future growth — are particularly sensitive to rate increases.

From an investor's perspective, higher yields on government bonds also reduce the incentive to take on the risk of owning equities.

SGOV invests in US Treasuries maturing within three months. Its key appeal is that its price moves relatively little even when interest rates shift. Bond prices generally fall when rates rise and rise when rates fall, and the longer a bond's maturity, the more sensitive it is to rate changes.

If an investor buys a bond with 10 years left to maturity and market rates subsequently rise, newly issued bonds will offer higher yields, making the older, lower-yielding bond less attractive and pushing its price down. Ultra-short bonds, by contrast, mature within months, allowing investors to reinvest the proceeds at the prevailing higher rate.

Short-term bond ETFs let investors earn interest income with less price-volatility risk than long-term bonds. They also serve as a parking spot for cash while investors wait for the right moment to buy equities.

The appeal of short-term bonds is especially pronounced when the Federal Reserve's policy direction is uncertain. Markets have priced in a rate hike at Wednesday's Federal Open Market Committee (FOMC) meeting. The focus now is on what comes after.

"The 10-year yield has climbed to 5.01 percent, surpassing its one-year high, and a 25-basis-point hike is already priced in," said Kim Se-hwan, a researcher at KB Securities. "The key question is whether Chair Wash will characterize this as a one-time recalibration or signal further tightening."

Investors can collect interest from short-term US Treasuries while monitoring the Fed's policy stance before deciding on their next move.

SGOV's assets under management stood at $109.5 billion as of Monday. Its dividend yield is approximately 3.69 percent, with distributions paid monthly. One notable feature is that interest accrues from the very first day of ownership.

Investors do not need to hold the ETF for a full month to receive a distribution. Interest income generated by the underlying Treasuries is reflected in the fund's net asset value daily, meaning investors who sell before the ex-dividend date can still capture accrued interest through the sale price.

However, the daily interest is not paid out separately in cash, nor is a fixed daily return guaranteed. Actual returns depend on the buy and sell prices and transaction costs.

Allocating assets to short-term Treasuries also features in what is often called Warren Buffett's "golden ratio portfolio." In his will, Buffett advised putting 90 percent of assets into an S&P 500 ETF and the remaining 10 percent into short-term US Treasuries — pursuing long-term returns through equities while keeping a portion of assets in instruments with limited price swings.

Buffett has cited liquidity as his reason for holding short-term US Treasuries: ensuring he has funds available when needed, even in times of market turmoil.

Ultra-short bonds have their limitations. Because their prices are less sensitive to rate movements, investors cannot expect the large capital gains that long-term bonds can deliver when rates fall sharply.

Falling rates also reduce interest income. Each time the underlying Treasuries mature, the proceeds must be reinvested at lower prevailing rates, which in turn reduces the distributions investors receive.

"The market has already priced in a significant portion of the rate-hike path extending into next year, so if oil prices stabilize, market rates face greater downside risk than upside," said Lee Jae-won, a researcher at Yuanta Securities Korea. "If short-covering of positions built up in anticipation of rate hikes kicks in on top of that, the pace of rate declines could be faster than expected."

Domestic investors must also factor in the exchange rate. Even if SGOV's dollar-denominated price remains stable, a weaker won against the dollar will reduce returns when converted back to won. If currency losses exceed interest income, investors could end up with a net loss in won terms.