Target Date Bond ETFs Reduce Rate Risk
April 1st, 2014 at 3:45pm by Max Chen
In anticipation of a rising interest rate environment, fixed-income investors have begun shifting down the yield curve. However, a number of target-date exchange traded funds provide an alternative option for those who are in for the long haul.
In a rising interest rate environment, bonds with a fixed lower rate are less desirable than a newly issued bond with the higher rate, so pre-existing zero-coupon bonds would see prices decline enough to match the same prevailing returns on the higher interest rates. Consequently, most investors would sell older bonds at a loss in order to reinvest in higher yielding securities.
Larger bond ETFs typically hold a basket of bond securities with varying maturities and re-allocates once a bond matures. Many ETFs come with an effective or average duration that measures the fund’s sensitivity to changes in interest rates. For example, if a hypothetical ETF has a 3 year effective duration, the fund would see its price dip 3% if interest rates were to rise 1%.
However, investors can also hold onto individual bonds until maturity to avoid realizing a short-term loss as they would regain the initial principal once the security matures plus interest payments. This is where target-date ETFs come into play.
Target-maturity ETFs only hold bonds that mature in a set year and distributes cash back to investors upon maturity. With target-maturity bond ETFs, investors can implement a type of bond ladder strategy that has evenly spaced out maturity dates to help minimize interest rate risk. Essentially, target-date bonds appeal to buy-and-hold investors who want a steady stream of income without the risk of losing their initial principal.
Currently, investors can select from a range of maturity-date bond ETFs from BlackRock’s iShares and Guggenheim Investments that cover investment-grade corporates, junk and municipal bonds, which provide investors with varying degrees of risk preferences and investment goals.
Guggenheim’s suite of BulletShares bond ETFs include target maturity dates as far out as 2022 on corporate debt and 2020 on junk debt. The Guggenheim BulletShares 2022 Corporate Bond ETF (NYSEArca: BSCM) has a 3.3% 30-day SEC yield and the Guggenheim BulletShares 2020 High Yield Corporate Bond ETF (NYSEArca: BSJK) has a 4.57% 30-day SEC yield. BSCM is up 3.2% and BSJK is up 2.9% year-to-date.
The iShares line includes muni and corporate bonds that mature up to the iShares 2019 AMT-Free Muni Term ETF (NYSEArca: MUAH) and iSharesBond Mar 2023 Corporate Term ETF (NYSEArca: IBDD). MUAH has a 0.99% 30-day SEC yield and IBDD has a 2.52% 30-day SEC yield.
For more information on target-maturity bonds, visit our target-date ETFs category.