SHY holds Treasuries with maturities between one and three years. Current yields on 2 and 3 yr Treasuries are 0.72% and 1.27% respectively. Yet, SHY yields well in excess of 1.5%. This should not be - a big difference like that, whether caused by NAV discount or capital gains distributions, should be arbitraged away (through creation/redemption of units) in such a liquid ETF.
I am obviously missing something. Can anyone explain this discrepancy?
After thinking some more (which I should have done before posting...), the reason must be that SHY is still holding a number of bonds bought prior to the Feds cutting rates, i.e., 1-3 year Treasuries with a higher coupon than current. This means that we can expect SHY net asset value to go marginally DOWN as older bonds get rolled over into new ones, even if interest rates stay the same. Obviously, if rates go up, the effect will be more pronounced.
This is the same as holding an older bond to maturity: the bond may be trading at higher than par if the coupon is higher than current market rates, but the value will eventually go back down to par.