As interest rates rise, long-term bond investors can take a look at target-date, defined-maturity or target-maturity bond exchange traded funds to limit interest-rate exposure.
Target maturity bond ETFs track a group of bonds that are expected to mature in a given year, collect on the bonds’ face value at maturity and pass the cash on to investors.
“These help mitigate the interest-rate exposure [of traditional bond funds] if you are a buy-and-hold investor…and they really are being used by buy-and-hold investors,” William Belden, head of product development at Guggenheim, said earlier in a Wall Street Journal article. [Defined-Maturity Bond ETFs for Higher Interest Rates]
Consequently, investors will receive the principal amount invested on the date of maturity, along with regular coupon payments – the interest rate stated on a bond when issued, which is also known as the coupon rate or coupon percent rate.
“In the years prior to the maturity year, the ETF collects interest from the bonds in the portfolio and pays it out to shareholders, just like other bond ETFs do, but no bonds mature,” writes Michael Iachini, CFA, CFP, Managing Director of ETF Research at Charles Schwab Investment Advisory.
“Then, over the course of the target year, the bonds in the ETF begin to mature. Instead of reinvesting the proceeds into other bonds, the ETF will hold the cash,” Iachini added. “By the end of the year, the expectation is for all of the bonds to have matured, leaving the ETF with only cash.”
In comparison, other bond ETFs that hold a basket of varying bond maturities will be subject to receive payments equal to the current market price of the shares, which is affected by interest rate risk. Consequently, broad basket bond ETFs can see prices decline if interest rates rise.
Currently, ETF investors can look through Guggenheim Investment’s line of BulletShares ETFs and iShares target year municipal and corporate bond ETF offerings.
Guggenheim offers a range of target-date investment-grade corporate bonds for yeac year from 2013 to 2020 and high-yield bonds for each year from 2013 to 2018.
iShares has a suite of target maturity municipal bond ETFs for each year from 2013 to 2018, and the firm recently launched corporate bonds target maturity bond ETFs that exclude the financial sector for the years 2016, 2018, 2020 and 2023.
For more information on bonds, visit our bond ETFs category.
Max Chen contributed to this article.