What Are Treasury Funds?

Treasury bond funds, or Treasury funds, are mutual funds that invest primarily in United States (US) Treasury bonds, which are marketable, income-producing debt securities issued by the United States government. Since Treasury bonds are backed by the creditworthiness of the US government, most investors consider Treasury funds a safer bond fund choice than corporate or municipal bond funds. Treasury bonds, however, have maturity dates of 10 years or more, making Treasury funds vulnerable to future price swings, prepayment risk, interest rate changes, and default risk. The duration of a Treasury fund can be calculated by finding the weighted average of the time left to the maturity date of each bond in the fund. Treasury funds produce a rate of return that is determined by both the change in the net asset value of the bonds and the value of the interest distributions paid out semiannually.

Interest rate decisions made by the Federal Reserve directly impact the net asset value of government bond funds, especially those containing mortgage-backed securities issued by government lending agencies, Treasury bills, notes, and other securities with maturity dates less than five years. The prices of long-term Treasury funds tend to be market driven. In 2010, Treasury funds posted returns as high as 10 percent, while the short-term funds only performed as high as four percent. Intermediate funds, with maturities of from five to 10 years, yielded from two to five percent in 2010.

The US government auctions Treasury bonds through noncompetitive and competitive bids. For noncompetitive bids, in which the bidder accepts a set rate, the maximum purchase amount is restricted to $5 million U.S. Dollars (USD). In competitive auctions, in which bidders submit rates that they are willing to pay, the maximum allowed purchase is up to 35 percent of the entire offering. Treasury funds not only contain Treasury bonds, but also some other Treasury securities with longer durations. Many Treasury funds strive to outperform the Long Treasury Bond Index, including Vanguard Long-Term US Treasury (VUSTX), T. Rowe Price U.S. Treasury Long Term (PRULX), and Dreyfus US Treasury Long Term (DRGBX).

Some government bond funds provide protection against inflation in the US economy. In these funds, the rates of return or the principal amounts are linked to the rises and falls in the inflation rate. Different funds offer different inflation protection strategies, making the rates of return variable from fund to fund. Investors should be aware that taxes apply not only to the income of the fund but also to any adjustments made to the principal.