Maturity Date Bond ETF's?

[grumpy]

I recently came across this article on Maturity Date Bond ETF's:

A Guide to Maturity-Date Bond ETFs - Seeking Alpha

I have never been a fan of bond mutual funds but this alternative sounds pretty attractive for the fixed income portion of my portfolio.

Does anyone have any experience with these? What do I need to look out for? Any feedback appreciated.

 

[pb4uski]

No, but I did seriously consider the Guggenheim funds recently when I converted my ex-employer 401k to my IRA. I would also be interested in others experience.

I ended up instead going with (at least for now) Vanguard Investment Grade Admiral (74% of fixed income), Vanguard GNMA (10%) and Vanguard High Yield Admiral (16%). At the time, this mix had a 3.75% yield and 4.8 duration, which were a lot better than Total Bond which had been my prior "go-to" fixed income fund.

If it appears that interest rates are about to rise I may dump those and go with the Guggenheim Bullet funds. I realize that the fair value will decline as rates rise but at least I know I would get my par back.

 

[LOL!]

Are these much different from closed-end funds from the likes of Nuveen?

 

[pb4uski]

I'm not familiar with the Nuveen funds but I think the Guggenheim funds are unique in that the bonds in the underlying portfolio will mature in the stated year and the proceeds from maturities will be distributed to investors in the fund. So the cash flow is the same as owning a portfolio of individual bonds that mature in the target year but you have more diversification that you might be able to achieve as an individual but pay 24bps management fees as a result.

 

[LOL!]

CEFs have a set number of shares and no new shares will be created. So the sponsor in this case would buy all the bonds ahead of time to create the amount of CEF shares needed and there would be no new shares created nor shares redeemed for the bonds. The expense ratio would come out of the dividends.

ETFs do not have a set number of shares, but have a way to create new shares if someone with enough capital comes along and buys all the underlying stocks and exchanges them for a share of the ETF. I can imagine for a bond fund maturing in a specific year that one could not really buy all those bonds 5 or 10 years in the future in order to create a share of the ETF, so this is a problem for me to understand how these things would work.

 

[Khufu]

I'm not familiar with the Nuveen funds but I think the Guggenheim funds are unique in that the bonds in the underlying portfolio will mature in the stated year and the proceeds from maturities will be distributed to investors in the fund. So the cash flow is the same as owning a portfolio of individual bonds that mature in the target year but you have more diversification that you might be able to achieve as an individual but pay 24bps management fees as a result.

These target date bond funds would seem to be an advantage if you have a timeline on a liability. Matching the duration of the ETF to your liability you would be indifferent to interest rate changes with the added benefit of diversification. However, for financing retirement and most other life goals, we don't have due dates. So, I don't really see the use of them. Maybe if you planned to buy an annuity at some later age you would want to put the premium amount into such a fund in the meantime.

 

[pb4uski]

I think the difference is that if interest rates increase say 300 bps and your bond mutual fund value declines 15% that you will eventually get that 15% loss in value back but it will take a very long time - as old bonds mature new bonds will be bought that yield the higher rate.

With this product I think you could recover quicker, as if you owned individual bonds that were maturing in a given year becaus you have more control over the cash flow structure of your fixed income portfolio than you would by owning good quality bond funds.

 

[Khufu]

I think the difference is that if interest rates increase say 300 bps and your bond mutual fund value declines 15% that you will eventually get that 15% loss in value back but it will take a very long time - as old bonds mature new bonds will be bought that yield the higher rate.

With this product I think you could recover quicker, as if you owned individual bonds that were maturing in a given year becaus you have more control over the cash flow structure of your fixed income portfolio than you would by owning good quality bond funds.

How quickly you recover depends on the weighted average duration of the bond portfolio whether it's in a bond fund or held in your own accounts. The advantage of having all the bonds mature at once, is that you know you will be made whole at the maturity date. But while in your scenario the bonds' maturing at par erases their market value losses, the opposite scenario is also possible. Rates could previously have dropped increasing the market value of the bonds, a gain that will be wiped out when they mature at par. Either way, having your principal returned on maturity date you now face the reinvestment rate risk on the whole chunk of your bond portfolio: the currently available rates may be unfavorable. (This is a risk for a bond portfolio that has a declining duration, but not for the more typical bond funds that have a rolling duration.)
You would not face such a reinvestment rate risk if the maturity date had been chosen to coincide with an expected liability, like paying for a child's college expenses.

On second thought, now I understand the purpose. If you wanted to construct a bond ladder getting corporate or muni rates but didn't want to concentrate the credit risk by buying individual bonds, you could create the ladder by using a series of these target date ETFs. There would be no need for such ETFs for Treasuries since they all have the same credit risk and that's why there are none.

 

[MichaelB]

Looking at the Guggenheim website, these ETFs are pretty thinly traded. If the volumes were high enough they might be an option for someone wanting to build a bond ladder.

I think a bond fund manager can do a better job than I can of figuring out what bonds and what maturities to hold to maximize returns.

 

[grumpy]

I am thinking about using these ETF's to build a bond ladder. I have a good bit of cash sitting in a Discover savings account earning 0.9% interest. These are not funds I anticipate needing in the foreseeable future.

My understanding is that these ETF's are currently trading at a discount to NAV so that is attractive. My concern is that I don't know what I don't know about this type of investment.

 

[jarts98]

Does anyone have any new experiences with these products? As with the earlier posts, I'm considering them for creating a bond ladder with less risk than individual bonds.

Thanks.

 

[RobLJ]

I am thinking about using these ETF's to build a bond ladder. I have a good bit of cash sitting in a Discover savings account earning 0.9% interest. These are not funds I anticipate needing in the foreseeable future.

My understanding is that these ETF's are currently trading at a discount to NAV so that is attractive. My concern is that I don't know what I don't know about this type of investment.

Since they are limited term that return cash at the end of the term, their primary use is to provide a pool of bonds for a bond ladder for investors who otherwise don't have enough capital to properly spread risk among different bonds.

 

[fossil_fuel]

These ETFs look like a very interesting way to save for shorter-term goals with a set timeframe. I'm going to look into putting part of my house-downpayment fund in these securities.

If they had longer-dated versions it would also be an excellent way to save for tuition, if only 529 plans had a brokerage window. That would address one of my main complaints with 529 plans: you're supposed to start switching to bonds as your childrens' matriculation date approaches, but you're being exposed to considerable interest rate risk in the event that rates rise just before your kid starts school. These target-date maturity funds eliminate that.