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By JT

Some ETFs have billions in assets. Some have mere millions. Last week I wrote about one of my favorite dividend ETF, which had assets in the millions. This week I’ll uncover another hidden gem in the bond market: the target maturity fund.

A target maturity fund invests in bonds with a fixed maturity date. For instance, a fund might hold only bonds that mature in 2015. Another might hold bonds that mature in 2017. These funds are designed to last only for a few years and then liquidate when the underlying assets reach maturation.

Why target maturity funds deserve more attention

Most bond funds track bonds with a known time to maturity. For instance, the iShares Barclays 20 Year Treasury Bond Fund (TLT) holds U.S. Treasuries with at least 20 years to maturity. Inside this particular fund are 22 different U.S. Treasury securities. When one bond has fewer than 20 years to maturity, it is sold and the proceeds are reinvested into another U.S. Treasury bond.

This setup is perfect for the short-term trader, but poor for the long-term investor. Because the underlying bonds are not held to maturity, these funds have higher interest rate sensitivity. When rates rise, investors in a rolling fund will necessarily lose money as bonds are sold at a price below the investors’ initial investment.

The only way to correct this inherent weakness is by holding several different rolling funds with ranging times to maturity. However, this adds unnecessary fees and costs, while failing to properly “smooth” out duration across all time periods.

The alternative to rolling funds is a target maturity fund. A target maturity fund purchases bonds and holds them to maturity. Thus, investors lose in nominal terms only if the fund is sold before maturity in a rising rate environment, or there is widespread default on the underlying bonds. Also, because the portfolio never changes from day to day or year to year, target maturity funds can operate with much lower expense ratios than indexed and actively-managed bond funds.

Target maturity funds worth owning

Only recently have target maturity funds come to market. The leaders in the space are iShares (go figure) and Guggenheim.

Municipal bonds

iShares has a long list of issues for municipal bonds. The AMT-Free portfolio series offers investors a tax-free income alternative with target dates that allow for precision. Plus, each municipal bond fund holds roughly 300 different issues for very broad exposure to the municipal bond market. These funds incur only minimal holding costs with expense ratios of .30% per year.

Here’s a list of iShares’ target maturity muni bond funds:

  • iShares 2013 S&P AMT-Free Municipal Bond Series ETF (MUAB)

  • iShares 2014 S&P AMT-Free Municipal Bond Series ETF (MUAC)

  • iShares 2015 S&P AMT-Free Municipal Bond Series ETF (MUAD)

  • iShares 2016 S&P AMT-Free Municipal Bond Series ETF (MUAE)

  • iShares 2017 S&P AMT-Free Municipal Bond Series ETF (MUAF)

  • iShares 2018 S&P AMT-Free Municipal Bond Series ETF (MUAG)

Corporate bonds

iShares also offers target maturity funds for corporate issues. The funds also ignore financials, which is part marketing and part common sense. We know from 2009 that AAA ratings in the financial space aren’t always earned or deserved. (Other funds cut out financials; the WisdomTree Dividend ex-Financials Fund (DTN) and Market Vectors Preferred Securities ex Financials ETF (PFXF) have done just fine cutting out financial companies.) An ex-financial strategy won’t cost you diversification, with these funds holding upwards of 90 investment-grade rated bonds. A .10% expense ratio is among the lowest in bond funds.

iShares’ four corporate bond funds are spread out through 7 years:

  • iShares 2016 Investment Grade Corporate ex-Financials Term ETF (IBCB)

  • iShares 2018 Investment Grade Corporate ex-Financials Term ETF (IBCC)

  • iShares 2020 Investment Grade Corporate ex-Financials Term ETF (IBCD)

  • iShares 2023 Investment Grade Corporate ex-Financials Term ETF (IBCE)

If you’re willing to keep financials in your portfolio, consider Guggenheim’s BulletShares products. Broadly diversified in nearly 300 bonds per fund and with expense ratios of .24%, BulletShares are an excellent way to hold a broad base of corporate bonds.

Here’s a list of Guggenheim’s target maturity corporate bond funds:

  • Guggenheim BulletShares 2013 Corporate Bond ETF (BSCD)

  • Guggenheim BulletShares 2014 Corporate Bond ETF (BSCE)

  • Guggenheim BulletShares 2015 Corporate Bond ETF (BSCF)

  • Guggenheim BulletShares 2016 Corporate Bond ETF (BSCG)

  • Guggenheim BulletShares 2017 Corporate Bond ETF (BSCH)

  • Guggenheim BulletShares 2018 Corporate Bond ETF (BSCI)

  • Guggenheim BulletShares 2019 Corporate Bond ETF (BSCJ)

  • Guggenheim BulletShares 2020 Corporate Bond ETF (BSCK)

High yield bond funds

Guggenheim’s BulletShares funds in the high-yield space are some of the most overlooked products on the market. The high-yield ETF space is dominated by two popular funds, SPDR Barclays Capital High Yield Bond ETF (JNK) and iShares iBoxx $ High Yid Corp Bond (HYG), but if you want to venture into high yield bonds, managing duration risk with target maturity funds makes a lot of sense, especially in a rising rate environment. At .42% per year, these BulletShares funds are less expensive than HYG (.50%) and only slightly more costly than JNK (.40% per year.)

Here is a list of Gugenheim’s target maturity high yield ETFs:

  • Guggenheim BulletShares 2013 High Yield Corporate Bond ETF (BSJD)

  • Guggenheim BulletShares 2014 High Yield Corporate Bond ETF (BSJE)

  • Guggenheim BulletShares 2015 High Yield Corporate Bond ETF (BSJF)

  • Guggenheim BulletShares 2016 High Yield Corporate Bond ETF (BSJG)

  • Guggenheim BulletShares 2017 High Yield Corporate Bond ETF (BSJH)

  • Guggenheim BulletShares 2018 High Yield Corporate Bond ETF (BSJI)

It’s time to make a move

Higher rates are not an “if” but a “when.” As the Fed ponders an end to its $85 billion quantitative easing program, investors should shore up their bond funds by moving to target maturity funds ahead of a Fed exit. While rising rates drives down all bonds (and bond funds), investors who use target maturity funds will have nothing to lose as each security is held to maturity.

Disclosure: No position in any tickers mentioned here.

Source: Target Maturity ETFs Shelter Bond Holdings From Rising Rates