Steven A. Baffico is a Senior Managing Director at Guggenheim Partners – Claymore Securities and is the Head of U.S. Retail Distribution for the firm. Within the Private Client Group, Mr. Baffico oversees areas including sales, marketing, product, key accounts, business analytics, product specialists, strategic initiatives and support teams for intermediary-sold investments. Guggenheim-Claymore’s Private Client assets currently total over $15 billion across ETF, Unit Trust, Closed-End funds and strategic investments encompassing nearly 100 offerings.
Darrin DeCosta is Head of Product Development for Accretive Asset Management LLC. In this role, Darrin is responsible for the market and product research employed by Accretive's patent-pending BulletShares™ investment methodology. Darrin was previously Director of Strategy and Corporate Development for Nuveen Investments, providing acquisition analysis, marketing, strategy and product support to senior management, product manufacturing and retail sales within the Nuveen Investments family. Prior to Nuveen Investments, Darrin held positions in product strategy, portfolio management and operations with Barclays Global Investors (now Blackrock), one of the world’s largest asset management firms.
Seeking Alpha's Jonathan Liss spoke with Steven (from the issuer's side) and Darrin (from the indexer's side) following Claymore's recent launch of its BulletShares suite of maturity-date corporate bond ETFs. The funds are an ETF first in that they offer date-specific exposure to the corporate bond market and offer investors the option of holding the ETF to maturity at which point they can collect a full payout as they would with any individual bond issue.
Jonathan Liss: Congrats on the BulletShares launch. Where did you guys come up with the idea to launch a suite of maturity-date corporate bond ETFs?
Darrin DeCosta: We began by taking an in-depth look at the fixed income marketplace. What we discovered is that financial advisors to high net worth individuals generally preferred purchasing individual bonds over packaged bond products such as ETFs, Mutual Funds or CEFs. Many of these products are actively managed which means their main goal is to generate alpha. Even indexed bond funds aren't sufficiently target-date/life-cycle driven for many investors' purposes. By focusing on a specific duration, these funds essentially treat every investor the same, offering them a duration that never wavers, regardless of how close they are to needing capital.
By and large, these products weren't really appropriate for their clients, who were looking to the fixed-income market to provide them with sufficient cash flow or address date-specific lifestyle issues like retirement. So advisors chose individual fixed-income securities which they laddered, because unlike a fund, you were promised a certain payout at maturity. But these created another problem which was a lack of diversification. A single bond defaulting would then be catastrophic to their clients. This dynamic in the fixed-income market led to the idea of BulletShares.
Steven Baffico: In our view, BulletShares offer the best of both worlds. They have the advantage of a specific maturity date at which point you receive the agreed upon return of principal as you would with any individual bond. Yet you also get the diversification offered by traditional bond funds.
Jonathan: Why did you decide to focus specifically on the investment grade corporate bond market?
Darrin: Those were the individual securities we found advisors were most frequently buying for their clients so we figured the market was ripe for a set of funds covering this space.
Jonathan: And at what point did Claymore enter the process?
Darrin: The kernel of the idea was something we at Accretive came up with on our own. As soon as we started getting serious about putting the actual indexes together, Claymore was on board. We consulted with them along the way including when we were constructing the different BulletShares indexes.
Jonathan: How are you defining 'investment grade' for the purpose of these funds?
Darrin: Every underlying index component needs at least one 'BBB' rating from at least one rating agency. In actuality, almost all the securities in the indexes have multiple ratings of 'BBB' or higher.
Steven: And in terms of the 'sampling' strategy we employ in choosing the fund holdings, this is certainly almost always the case.
Jonathan: What kind of yields can investors expect on these funds?
Steven: Starting on the near end of the BulletShares yield curve (2011/BSCB), investors can expect a 12-month yield of 100 bps, paid out monthly. On the far end of the yield curve (2016/BSCG - 2017/BSCH), we expect a 12-month yield of somewhere between the high 300s to the low 400s bps, which again will be paid out monthly.
Darrin: The actual yields will vary somewhat between the underlying indexes and what the ETFs pay out based on sampling and which securities end up in the ETFs.
Jonathan: How exactly will BulletShares' sampling methodology be employed? How many issues are you expecting each of these funds to hold?
Steven: Our starting point is a group of indexes that range from having 95 to 190 securities each. Using Guggenheim's extensive research infrastructure - research which is routinely rated tops in the market in terms of security analysis - we will arrive at a group of 30-40 securities per ETF, at least as our starting point. This number may be expanded over time as additional corporate bonds are issued with maturities in a given year.
Jonathan: Looking at some of the competition in the ETF market, how do BulletShares stack up against an ETF like iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)?
Darrin: LQD's underlying index, the iBoxx $ Liquid Investment Grade Index, tracks only the most liquid portion of the investment grade corporate credit market. As a result, LQD has very high levels of turnover in its holdings - something whose effect on LQD's performance isn't immediately clear to most investors. To get specific, last year LQD had an annual turnover rate of 79% and this refers only to rebalancing, which is the rate that gets reported to the SEC. There was the additional turnover that results from the ETF share creation/redemption process. This much turnover can lead to tracking error as well as diminished fund performance. And if you look at how LQD has performed (it was launched in July 2002), its tracking error has gotten progressively worse.
Contrast this with how BulletShares are constructed. These funds are designed to hold securities to maturity, which means an extremely low turnover, and thus better tracking of its benchmark as well as lower costs to run the associated fund. In my mind, this is one of the key measures of quality index construction.
Steven: The dynamics of the negotiated OTC market for corporate bond issues mean replication and tracking error are primary in these types of products. The way Accretive constructed the BulletShares' indexes makes Claymore's job that much easier.
Jonathan: One unique and in my mind excellent feature of BulletShares is that ETF investors can hold these funds to maturity. What happens though if one of the underlying components has its credit rating downgraded or defaults altogether before reaching maturity?
Darrin: There are really two sets of rules for dealing with the early termination of a security, or with a credit rating downgrade. Along the way, the funds are rebalanced monthly and this takes into account newly available securities, downgrades, defaults and the like. The second set of rules applies to the fund's final year. As the ETF doesn't terminate until December 31 of a specified year but the various holdings reach maturity beginning anytime after January 1 of that year, they are rolled into short-term (13 weeks or less) treasuries or money market funds with the intent of continuing to earn interest income while keeping the newly available capital as safe as possible leading up to a fund's termination.
Jonathan: Taking a glance at some of the holdings, I noticed that these funds are heavily weighted toward financials (On the short end of the curve, BSCB is 43% weighted to financials. On the long end, BSCH is 52% weighted to financials). Why is that?
Steven: The heavy weighting toward financials is a reflection of how the overall investment grade corporate bond market looks today. The sector weightings reflect the character of a particular vintage or maturity year.
Since 2008, when the financial crisis began, there's been a paradigm shift into low volatility, low return assets in funds like iShares Barclays Aggregate Bond ETF (AGG), which is now heavily in Treasuries. In 2007, AGG was less than 30% weighted to Treasuries, with a much higher corporate bond weighting, meaning much better yields. Now in 2010, 80% of AGG is comprised of Treasuries, meaning much lower volatility but also significantly lower yields. Investors now need to venture into the corporate bond market themselves if they want proper exposure to the entirety of the fixed income space. A one-and-done fund like AGG no longer provides this.
Jonathan: When can investors expect to see the last three BulletShares funds (2018, 2019, 2020) begin trading?
Steven: Our hope is relatively soon. To some degree, it depends on how well this initial launch goes. We’ve been very satisfied with the buzz this launch has received.
In terms of other funds that stretch beyond 2020, we need to make sure there's enough diversification in terms of bond issues for a given year before considering launching additional BulletShares at this time.
Jonathan: Is lack of diversification a serious concern beyond 2020?
Darrin: The vast majority of corporate bond issuance is for a duration of 5 or 10 years. There are also 30-year issues although these are significantly less common. Additionally, these securities need to be very liquid for consideration in the indexes. There are, at this point, at least 60 securities that meet our criteria for the 2020 fund and as it's only June, we expect this number to increase as 2010 progresses as 10-year bond issues generally come out exactly 10 years prior to their maturity date (so for example, a 10-year corporate bond that matures in December 2020 won't be issued until December of this year). Beyond the 10 year mark, there's not much there.
Jonathan: Darrin, does Accretive have plans to work alongside other ETF issuers in the future? Are there plans to work on other product suites with Claymore?
Darrin: We have no immediate plans beyond the remaining three BulletShares for the moment. However generally speaking, we believe there is a great opportunity to broaden the BulletShares methodology at a future point.
Steven: Claymore believes BulletShares is scalable to other areas of the fixed income market including a variety of more complex credit instruments, which may be less familiar to the average investor but which there is a definite market for among investment professionals.
Jonathan: Steven, a few questions for you regarding Guggenheim's entry into the ETF business. Are there plans for further acquisitions? What sort of synergies (if any) is Guggenheim hoping to achieve between Rydex and Claymore?
Steven: Right now, we are in the process of fully integrating Claymore. It's a logical fit between a manufacturing-only firm (Guggenheim) and a distribution-only firm (Claymore) which will give Guggenheim an opportunity to grow organically within the investment products business. The plan is ultimately to package across an array of credit products, including ETFs, CEFs and Investment Trusts.
The real story in the Claymore acquisition is Guggenheim's entry into the client product space. Our goal is to provide institutional expertise to individual investors - and Claymore's a great channel for that.
With regard to Rydex, that acquisition was part of a larger M&A deal for Security Benefit Corp. Rydex and Claymore operate entirely independently of each other, with different boards, etc. Speculating about synergies between the two ETF issuers and the like is premature at best at this stage.
Jonathan: It sounds to me like you guys are making a distinction between 'BulletShares' and ETFs. is that accurate?
Steven: Well BulletShares certainly have a non-traditional application relative to most ETFs but these funds function just like ETFs and offer all the benefits ETFs traditionally have including taxation issues, transparency, and the creation/redemption process which keeps them trading very close to NAV.
Darrin: In my mind, the specific 'packaging' is less important than BulletShares' indexing methodology. Index methodology really matters. Lower turnover almost always means a more positive product experience. Turnover can be very costly, both in terms of tracking error and performance. The best way to get out of a bond is to hold it to maturity from both a cost and capital gains perspective. And of course, it's nice to have the efficiencies and transparencies that ETFs offer as well.
Steven: Ultimately, BulletShares are about offering the Guggenheim private wealth experience in low barrier to entry products.
Jonathan: How would you compare BulletShares to some of the more basic target-date ETFs out there (XShares and iShares both offer lines of Target-Date/Life-Cycle ETFs)?
Steven: Target-Date funds are much less malleable for individual investor needs than are BulletShares.
Darrin: Also, Target-Date funds are over-simplified and generally designed for defined contribution plans. The problem with them is they help you save until the date in question but once you reach that date, they don't help you 'spend', or provide an income, so to speak. They are focused on the average investor but in my experience, very few investors are really 'average'. BulletShares allow for extremely individualized investment strategies to be executed.
Steven: BulletShares are about how to offer investors a more targeted tool kit in an increasingly complex fixed-income market landscape.
Jonathan: This has been extremely interesting. Thanks for taking the time to answer my questions Steven and Darrin and good luck with BulletShares.