If you expect rates to rise, you can target shorter-dated funds and simply reinvest the proceeds into longer-dated funds as rates increase. If you’re not sure about the direction of rates, you can invest in a laddered portfolio of funds that will provide you the opportunity to reinvest proceeds at regular intervals in the future.
The potential benefits of bond ladders
A ladder is a portfolio of bonds that mature at staggered intervals across a range of maturities. Assuming rates rise, proceeds from each maturing rung of defined maturity ETFs can be reinvested in longer-dated funds at higher rates. If market interest rates fall or remain flat, fund holders can stay invested and take the proceeds when the funds mature.
By bond laddering with defined maturity ETFs, investors can generate regular income through a diversified range of maturities while maintaining the liquidity offered by the ETF structure. (Of course, diversification does not ensure a profit or protect against loss.)
Example of a laddered portfolio
Not all defined maturity ETFs are structured the same, of course. Some funds hold bonds that can be called in the event of falling interest rates. This shouldn’t be a problem for many investors, as there is a generally a premium associated with callable bonds, and callable bonds often feature higher yields than non-callable bonds.
Defined maturity ETFs also allow you to take advantage of the cost- and tax-efficient ETF structure4, while eliminating time-intensive bond credit research. Defined maturity ETF holdings are generally selected by a rules-based methodology and, depending on which defined maturity ETF you choose, you can access either investment grade or high yield credits.
Investors interested in defined maturity ETFs may wish to consider Invesco’s BulletShares suite of ETFs, which offers the choice of investment grade or high yield bond exposure.
This article has been republished form Invesco Powershares.