The Treasury yield curve flattened over the third quarter. Long-term yields declined due to increased geopolitical risks and concerns about sluggish global growth, despite the Federal Reserve's ongoing tapering of its monthly asset purchases. Short- and intermediate-term yields, however, increased as investors began to anticipate the onset of Fed rate hikes starting mid-2015. Following its September policy meeting, the Fed kept the phrase "for a considerable time" in its description of how long the central bank will maintain the target fed funds rate at its current level after ending its asset purchases, which eased anxiety about the initial tightening move coming sooner than expected.
The U.S. Treasury Long-Term Fund returned 2.48% in the quarter compared with 2.69% for the Barclays U.S. Long Treasury Bond Index and 1.02% for the Lipper General U.S. Treasury Funds Average. For the 12 months ended September 30, 2014, the fund returned 10.70% versus 11.60% for the Barclays U.S. Long Treasury Bond Index and 5.53% for the Lipper General U.S. Treasury Funds Average. The fund's average annual total returns were 10.70%, 6.40%, and 6.46% for the 1-, 5-, and 10-year periods, respectively, as of September 30, 2014. The fund's expense ratio was 0.52% as of its fiscal year ended May 31, 2014.
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The fund invests at least 85% of its assets in Treasuries but maintains small positions in securities backed by the U.S. government, including Treasury inflation-protected securities (TIPS) and Ginnie Mae mortgage-backed securities (MBS). TIPS provide some inflation protection, while our MBS holdings provide added yield over Treasuries, decent liquidity, and diversification for the fund. The fund's duration, which measures its sensitivity to changes in interest rates, was shorter relative to the benchmark, as we stayed on the defensive against the risk of rising rates given the improving U.S. economy and a less accommodative Fed. Our shorter duration posture versus the index weighed on relative returns over the quarter as declining long-term yields resulted in strong performance for longer-dated Treasuries.
The U.S. economy continues to improve and the dollar has recently strengthened as Europe, Japan, and China are showing signs of deceleration. Though the improving economy could put upward pressure on U.S. rates, we believe that the stronger dollar and benign inflation readings will likely attract foreign buyers and restrain U.S. yields. In addition, further monetary easing in Europe to bolster the eurozone economy could hold yields down in Europe and the U.S. The fund continues to maintain a short duration versus the benchmark as diminishing slack in the labor market and rising wage inflation point to an eventual Fed rate hike. The front of the yield curve will likely see the most pressure as the market prices in the timing and pace of tightening. At the long end of the curve, the presence of large institutional buyers and the cheapness of Treasuries versus other developed market sovereign bonds could moderate a rise in yields.