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Fund Spotlight Series – Defined Maturity Funds

New funds from iShares and Guggenheim offer investors a combination of investing in individual bonds and bond funds. Are they right for you?

The Short:

 

Pros:

These funds offer investors some advantages of investing in specific individual bonds, while also allowing diversification that many investors can not afford investing in individual bonds.

Funds are offered at a very reasonable cost to investors.

Offers investors a way to protect their fixed income investments against a rise in interest rates.

All funds discussed below may a monthly dividend.

 

Cons:

Still not the same as an individual bond. Varied dividend payouts, and declining yield near the end of the fund’s scheduled life.

Little liquidity in some of the funds.

Very new to the market. Not a lot of history on how these types of funds will perform in different environments.

 

In this post we compare funds managed by iShares and Guggenheim Investments. iShares sports the lowest expense ratio (all funds  have an expense ratio of only 0.10%), while Guggenheim’s funds offer a little better liquidity, slightly higher yield (for a number of reasons, as we discuss below) and diversity from a larger number of holdings and by including financial companies in their holdings. However those advantages also come with a slightly higher expense ratio (0.24% for regular funds, 0.42% for junk bond funds).

 

The Long:

 

 

A typical bond gives an investor a known, consistent interest payment over time until the bond matures. At the time of maturity the investor receives his original investment (known as his principal) back in full.

(click to enlarge)

 

 How a bond works

 

As long as bonds are held until maturity, the investor does not have to worry about the day to day price changes in the bond. As long as the company remains solvent the investor will simply keep collecting the scheduled interest payments, and receive his principal back in full at maturity.

 

Individual corporate bonds typically have very high minimum investment amounts, making diversification nearly impossible for most personal investors.

 

Shown below is a typical bond offering (using Scottrade). For this bond from FEDEX, an investor needs a minimum of over $13,000 to be able to invest in these bonds. For most investors, this would add too much risk into their portfolio because a single company would make up a significant part of their portfolio.  (There is no set rule from how much is too much, but I like to follow the rule of no more than 5% of my portfolio exposed to any individual company. This means unless your portfolio is over $260,000, just meeting the minimum investment of this bond exposes you too much to FEDEX.)

(click image below to enlarge)

 

Example min bond purchase

 

 

For new investors, check out of definition page where some of these terms are defined in much greater detail. Also, look for important terms in this post to be linked to their corresponding definition page.

Our definition page on bonds can be found here.

 

 

Because of this high minimum on individual corporate bonds and the difficulty to diversify with individual bonds, investors have been using bond ETFs and mutual funds. These funds invest in thousands of bonds and, for a small fee, allow investors to be able to spread their investments out into thousands of different bonds.

 

Typical bond funds do have a downside though.

 

Consider a long term corporate bond fund, Ticker: LQD ran by iShares. This ETF holds nearly 2000 different bonds, with a average maturity of 11 years.

Investors like long term bond funds because of their increase in yields over short term funds. LQD yields around 3% today, while a shorter term corporate bond fund such as iShares short term bond fund, Ticker: CSJ (which has an average maturity of just under 2 years) yields only 1.2%.

 

But longer term bonds are more sensitive to changes in interest rates. As interest rates change, the bond’s price will change. (Recall for bonds yields move opposite direction of prices).

 

If long term interest rates were to increase, the prices of the bonds held by funds such as LQD would drop, and therefore the share price of LQD would drop as well.

 

Whereas if you held some of the individual bonds instead of the ETF, you would at least know that you will get your principal paid back in full. However when you decide to sell LQD, the share price may not be where it was when you bought it, even though many of the bonds held in the fund’s portfolio may have matured.

 

Below is a chart of the share price of LQD over the last decade. As you notice, the share price is somewhat volatile. Remember, the bond portion of your asset allocation is there to reduce volatility and hedge the risks associated with investing in stocks. If interest rates rise, the share price of LQD may never recover from where it is now, meaning that your initial investment into LQD may not be worth as much when you try and sell your shares.

 

LQD-long term chart

 

So what is the best way for investors to invest in bonds? Take on tremendous risk by investing large portions of their portfolio into only a few company’s bonds for a promise of full principal return at maturity (As long as the companies remain solvent of course)? Or invest in bond funds which may see their share price decline if interest rates rise, leaving you with a potential loss of principal?

 

Well, several sharp fund managers have come up with a combination of the best of both worlds.

 

Target Maturity Bond Funds.

 

These funds only invest in bonds that mature in a specific year. After all the bonds in the fund’s portfolio mature, the funds are liquidated and all cash is distributed back to shareholders.

Lets look into one of the funds offered (a complete list is further down below): iSharesBond 2016 Investment Grade Corporate Bond ETF (Ticker: IBCB)

 

As the name implies, this fund only invests in corporate bonds which mature between April 2015 and March 2016. Around early April 2016 the fund will liquidate and return all cash to then current shareholders.

You simply buy the fund, which currently invests in over 100 different individual corporate bonds, and sit back and receive monthly dividends from the fund. After all the bonds in the fund’s portfolio mature, you get cash deposited back into your account. This is much different than the ETF LQD discussed above, where as bonds in the fund’s portfolio mature, the fund immediately invests into new bonds.

 

 

These are passively managed funds, updated once per month to keep up with the index they are following. The funds will cease re balancing to track the index in the last year of the funds existence. At that point in time, money within the fund from the maturing bonds will be placed in cash and cash equivalents (such as CDs, money market funds etc.).

 

So, starting around April 2015, the fund will slowly morph into essentially a money market fund as bonds mature. Unfortunately, this means that the funds dividends will not remain consistent, and will seemingly decline substantially. This risk is highlighted specifically in the fund’s prospectus:

 

Declining Yield Risk. During the twelve months prior to the Fund’s planned termination date, its yield will generally tend to move toward prevailing money market rates, and may be lower than the yields of the bonds previously held by the Fund and lower than prevailing yields for bonds in the market.”

 

Today, the nation wide average yield for a money market fund is about 0.1%, so investors can expect to see a steady drop in dividends over the last year of the fund if interest rates stay where they are today.

 

iShares currently offers 4 of these funds, but expect more and more to come to the market as these funds liquidate and they get more popular.

All of the funds offered by iShares invest only in Investment Grade bonds (rated BBB- or above), and do not invest in any financial company bonds. (The funds offered by Guggenheim below do invest in both “junk” bonds and include financials.)

 

iSharesBond 2016 Investment Grade Corporate Bond ETF (Ticker: IBCB)

-Average yield to maturity of 0.7%

-Made up of 102 holdings

-Expense Ratio of 0.10%

-Estimated liquidation date on or around March 31st 2016.

 

The fund’s fact sheet shows how the fund’s investments will slowly turn into cash and cash equivalents over the last year.

Index weight by month: (subject to change as the fund rebalanced each month – check the fund’s fact sheet for the latest numbers.)

 IBCB maturity by month

 

So after June 2015, your “bond fund” will really be over 20% in cash! Beware of this when investing in the funds and holding until maturity.

 

More facts on the fund can be found on the iShare’s page here: http://us.ishares.com/product_info/fund/overview/IBCB/index.htm

The fund’s prospectus can be found here: http://prospectus-express.newriver.com/get_template.asp?clientid=isharesll&fundid=46432F792&doctype=pros

 

 

iSharesBond 2018 Investment Grade Corporate Bond ETF (Ticker: IBCC)

 

-Average yield to maturity of 1.37%

-Made up of 83 holdings

-Expense Ratio of 0.10%

-Estimated liquidation date on or around March 31st 2018.

-Average daily volume of about 5,000 shares.

 

More information on the fund can be found on iShares website, here: http://us.ishares.com/product_info/fund/overview/IBCC.htm

The fund’s prospectus can be found here:http://prospectus-express.newriver.com/get_template.asp?clientid=isharesll&fundid=46432F768&doctype=pros

 

iSharesBond 2020 Investment Grade Corporate Bond ETF (Ticker: IBCD)

 

-Average yield to maturity of 2.11%

-Made up of 81 holdings

-Expense Ratio of 0.10%

-Estimated liquidation date on or around March 31st 2020.

-Average daily volume of 8,000.

 

More information on the fund can be found on iShare’s website, here: http://us.ishares.com/product_info/fund/overview/IBCD.htm

The fund’s prospectus can be found here: http://prospectus-express.newriver.com/get_template.asp?clientid=isharesll&fundid=46432F735&doctype=pros

 

iSharesBond 2023 Investment Grade Corporate Bond ETF (Ticker: IBCE)

-Average yield to maturity of 2.8%

-Made up of 113 holdings

-Expense Ratio of 0.10%

-Estimated liquidation date on or around March 31st 2023.

-Average daily volume of 6,400

 

 

More information on the fund can be found on iShare’s website, here: http://us.ishares.com/product_info/fund/overview/IBCE.htm

The fund’s prospectus can be found here: http://prospectus-express.newriver.com/get_template.asp?clientid=isharesll&fundid=46432F693&doctype=pros

 

 

Guggenheim Investments currently offers 14 of these funds, 8 of which invest in investment grade bonds, 6 of which invest in high yield or “junk” bonds. These funds operate under similar guidelines as the iShares funds, with a couple of minor differences.

 

Guggenheim states that some of their funds do not start accumulating cash and cash equivalents until 6 months before the fund liquidates. This may give investors slightly higher dividends over the start of the last year of the fund compared to iShares funds.

From the 2014 fund’s prospectus:

“In the last six months of operation, when the bonds held by the Fund mature, the Fund’s portfolio will transition to cash and cash equivalents, including without limitation U.S. Treasury Bills and investment grade commercial paper.”

The warning of reduced yields near the end of the fund’s life is stated in Guggenheim’s fund prospectus as well:

“Declining Yield Risk
During the final year of the Fund’s operations, as the bonds held by the Fund mature and the Fund’s portfolio transitions to cash and cash equivalents, the Fund’s yield will generally tend to move toward the yield of cash and cash equivalents and thus may be lower than the yields of the bonds previously held by the Fund and/or prevailing yields for bonds in the market.”
However it does appear that Guggenheim’s funds do start accumulating cash and cash equivalents earlier than 6 months. Take a look at the holdings for the 2013 junk bond fund (discussed in detail below):
2013 Guggenheim fund holdingsEven though the fund will not liquidate for another 7 months, the fund is already in nearly 20% cash equivalents (short term treasury bills).  After looking at several of the funds, many of the fund’s fact pages say that cash and cash equivalents will not be accumulated until the last 6 months, while prospectuses say 12 months. Take note of the fund’s holdings before investing, it may not be a huge deal in the long run, but it may mean the dividends sent out by the fund begin to drop off at an earlier time. I will try and get clarification from Guggenheim about this and update when I hear back from them.

Also, Guggenheim has designed these funds to liquidate at the end of December of the target year. Recall that iShares 2016 fund liquidated in April 2016? Guggenheim plans to liquidate on or about December 31st 2016.

Guggenheim’s funds invest in financial company bonds, unlike iShares and carry a slightly higher expense ratio than iShares.

 

With all that said, lets take a look at the specific funds:

 

Guggenheim offers 8 which invest in investment grade bonds. These will be the closest in comparison to iShares funds discussed above:

 

 

 

Guggenheim BulletShares 2013 Corporate Bond ETF (Ticker: BSCD)

-Weighted Average Yield to Maturity: 0.58%

-Made up of 124 holdings

-Expense Ratio of 0.24%

-Estimated liquidation date on or around December 31st 2013.

-Average daily volume of 29,700

More information can be found on the fund’s webpage here: http://guggenheiminvestments.com/products/etf/bscd

The fund’s prospectus is found here: http://guggenheiminvestments.com/GuggenheimInvestments/media/etfdoclib/gf/SumPro-BSCD.pdf?ext=.pdf

 

Guggenheim BulletShares 2014 Corporate Bond ETF (Ticker: BSCE)

 

-Weighted Average Yield to Maturity: 0.73%

-Made up of 235 holdings

-Expense Ratio of 0.24%

-Estimated liquidation date on or around December 31st 2014.

-Average daily volume of 56,800

 

More information can be found on the fund’s fact page here: http://guggenheiminvestments.com/products/etf/bsce

The fund’s prospectus can be found here: http://guggenheiminvestments.com/GuggenheimInvestments/media/etfdoclib/gf/SumPro-BSCE.pdf?ext=.pdf

 

Guggenheim BulletShares 2015 Corporate Bond ETF (Ticker: BSCF)

-Weighted Average Yield to Maturity: 0.91%

-Made up of 284 holdings

-Expense Ratio of 0.24%

-Estimated liquidation date on or around December 31st 2015.

-Average daily volume of 86,600

More information can be found on the fund’s webpage here :http://guggenheiminvestments.com/products/etf/bscf

The fund’s prospectus is found here: http://guggenheiminvestments.com/GuggenheimInvestments/media/etfdoclib/gf/SumPro-BSCF.pdf?ext=.pdf

 

Guggenheim BulletShares 2016 Corporate Bond ETF (Ticker: BSCG)

-Weighted Average Yield to Maturity: 1.17%

-Made up of 234 holdings

-Expense Ratio of 0.24%

-Estimated liquidation date on or around December 31st 2016.

-Average daily volume of 60,800

More information can be found on the fund’s webpage here: http://guggenheiminvestments.com/products/etf/bscg

The fund’s prospectus is found here: http://guggenheiminvestments.com/GuggenheimInvestments/media/etfdoclib/gf/SumPro-BSCG.pdf?ext=.pdf

 

Guggenheim BulletShares 2017 Corporate Bond ETF (Ticker: BSCH)

-Weighted Average Yield to Maturity: 1.55%

-Made up of 253 holdings

-Expense Ratio of 0.24%

-Estimated liquidation date on or around December 31st 2017.

-Average daily volume of 76,400

More information can be found on the fund’s webpage here: http://guggenheiminvestments.com/products/etf/bsch

The fund’s prospectus is found here: http://guggenheiminvestments.com/GuggenheimInvestments/media/etfdoclib/gf/SumPro-BSCH.pdf?ext=.pdf

 

Guggenheim BulletShares 2018 Corporate Bond ETF (Ticker: BSCI)

-Weighted Average Yield to Maturity: 1.82%

-Made up of 175 holdings

-Expense Ratio of 0.24%

-Estimated liquidation date on or around December 31st 2018.

-Average daily volume of 51,900

More information can be found on the fund’s webpage here: http://guggenheiminvestments.com/products/etf/bsci

The fund’s prospectus is found here: http://guggenheiminvestments.com/GuggenheimInvestments/media/etfdoclib/gf/SumPro-BSCI.pdf?ext=.pdf

 

Guggenheim BulletShares 2019 Corporate Bond ETF (Ticker: BSCJ)

-Weighted Average Yield to Maturity: 2.08%

-Made up of 162 holdings

-Expense Ratio of 0.24%

-Estimated liquidation date on or around December 31st 2019.

-Average daily volume of 25,500

More information can be found on the fund’s webpage here: http://guggenheiminvestments.com/products/etf/bscj

The fund’s prospectus is found here: http://guggenheiminvestments.com/GuggenheimInvestments/media/etfdoclib/gf/SumPro-BSCJ.pdf?ext=.pdf

 

Guggenheim BulletShares 2020 Corporate Bond ETF (Ticker: BSCK)

-Weighted Average Yield to Maturity: 2.60%

-Made up of 127 holdings

-Expense Ratio of 0.24%

-Estimated liquidation date on or around December 31st 2020.

-Average daily volume of 20,000

More information can be found on the fund’s webpage here: http://guggenheiminvestments.com/products/etf/bsck

The fund’s prospectus is found here: http://guggenheiminvestments.com/GuggenheimInvestments/media/etfdoclib/gf/SumPro-BSCK.pdf?ext=.pdf

 

 

 

Guggenheim also offers defined maturity funds that invest in junk bonds. These funds will have a higher yield because they are invested in bonds issued by less credit worthy companies (as rated by the credit rating agencies). These funds should have increased volatility in price and increased default risk compared to the investment grade funds above. The added default risk means that there is a higher chance that your initial investment in the fund will not be returned in full because some companies may default on their bonds. These funds are decently diversified, so the risk should be low, but beware of it nonetheless.

These junk bond funds also come with a higher expense ratio than their investment grade counterparts.

 

The 6 fund which invest in high yield, or “Junk”,  bonds:

 

 

Guggenheim BulletShares 2013 High Yield Corporate Bond ETF (Ticker: BSJD)

-Weighted Average Yield to Maturity: 4.45%

-Made up of 74 holdings

-Expense Ratio of 0.42%

-Estimated liquidation date on or around December 31st 2013.

-Average daily volume of 20,000

More information can be found on the fund’s webpage here: http://guggenheiminvestments.com/products/etf/bsjd

The fund’s prospectus is found here: http://guggenheiminvestments.com/GuggenheimInvestments/media/etfdoclib/gf/ETF-PRO-BULLETSHARES-0912_linked.pdf?ext=.pdf

 

Guggenheim BulletShares 2014 High Yield Corporate Bond ETF (Ticker: BSJE)

-Weighted Average Yield to Maturity: 5.03%

-Made up of 138 holdings

-Expense Ratio of 0.42%

-Estimated liquidation date on or around December 31st 2014.

-Average daily volume of 83,000

More information can be found on the fund’s webpage here: http://guggenheiminvestments.com/products/etf/bsje

The fund’s prospectus is found here: http://guggenheiminvestments.com/GuggenheimInvestments/media/etfdoclib/gf/ETF-PRO-BULLETSHARES-0912_linked.pdf?ext=.pdf

 

Guggenheim BulletShares 2015 High Yield Corporate Bond ETF (Ticker: BSJF)

-Weighted Average Yield to Maturity: 4.88%

-Made up of 115 holdings

-Expense Ratio of 0.42%

-Estimated liquidation date on or around December 31st 2015.

-Average daily volume of 118,000

More information can be found on the fund’s webpage here: http://guggenheiminvestments.com/products/etf/bsjf

The fund’s prospectus is found here: http://guggenheiminvestments.com/GuggenheimInvestments/media/etfdoclib/gf/ETF-PRO-BULLETSHARES-0912_linked.pdf?ext=.pdf

 

Guggenheim BulletShares 2016 High Yield Corporate Bond ETF (Ticker: BSJG)

-Weighted Average Yield to Maturity: 4.95%

-Made up of 111 holdings

-Expense Ratio of 0.42%

-Estimated liquidation date on or around December 31st 2016.

-Average daily volume of 54,000

More information can be found on the fund’s webpage here: http://guggenheiminvestments.com/products/etf/bsjg

The fund’s prospectus is found here: http://guggenheiminvestments.com/GuggenheimInvestments/media/etfdoclib/gf/ETF-PRO-BULLETSHARES-0912_linked.pdf?ext=.pdf

 

Guggenheim BulletShares 2017 High Yield Corporate Bond ETF (Ticker: BSJH)

-Weighted Average Yield to Maturity: 4.60%

-Made up of 107 holdings

-Expense Ratio of 0.42%

-Estimated liquidation date on or around December 31st 2017.

-Average daily volume of 43,600

More information can be found on the fund’s webpage here: http://guggenheiminvestments.com/products/etf/bsjh

The fund’s prospectus is found here: http://guggenheiminvestments.com/GuggenheimInvestments/media/etfdoclib/gf/ETF-PRO-BULLETSHARES-0912_linked.pdf?ext=.pdf

 

Guggenheim BulletShares 2018 High Yield Corporate Bond ETF (Ticker: BSJI)

-Weighted Average Yield to Maturity: 5.58%

-Made up of 116 holdings

-Expense Ratio of 0.42%

-Estimated liquidation date on or around December 31st 2018.

-Average daily volume of 33,500

More information can be found on the fund’s webpage here: http://guggenheiminvestments.com/products/etf/bsji

The fund’s prospectus is found here: http://guggenheiminvestments.com/GuggenheimInvestments/media/etfdoclib/gf/ETF-PRO-BULLETSHARES-0912_linked.pdf?ext=.pdf

 

 

In Conclusion

 

I believe these funds are a great addition for the individual investor. By moving a portion of your bond allocation to a fund such as these investors can eliminate some interest rate risk within their portfolio.

Setting up a type of bond ladder in these funds would be a very nice addition to a general bond fun in a portfolio if investors want to manage it.

 

It is tough to pick a winner between iShares and Guggenheim. iShares always offers quality funds and great expense ratios, but Guggenheim’s funds have gained a little more attraction by the market and see much more volume on average. Only seeing a few thousand shares traded daily in the iShares funds scares me a little bit that liquidity is just not quite there. But, for an investor who is holding these funds til maturity, it is probably not a big deal.

I have never been a fan of junk bonds, in my opinion money allocated to junk bonds should just be put into stocks instead. But these funds may offer a great addition to investors who do use junk bonds in their portfolio.

 

Thank you for reading!

Defined maturity funds not your thing? Check out our other Fund Spotlight Series here.

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