Four Junk-Bond ETFs on the Horizon

by: Roger Nusbaum

A while back the ETF provider now known as Guggenheim listed an ETF line called "BulletShares" for corporate bonds, which allowed investors to access a specific maturity date such that -- with the BulletShares 2014 Corporate Fund (NYSEARCA:BSCE) -- the bonds held in the fund would all mature throughout that year, and the fund would close when the last bond matured. This offers more precise management of average maturity in a bond portfolio than other funds do.

As a practical matter, if I really wanted to target 2014 I might go with the 2015 fund, because the 2014 fund starts liquidating due to maturation as soon as January 15, 2014. I would also add that buying individual issues that are investment grade is not terribly difficult, beyond trying to minimize the chance that something you buy today isn't going to get called tomorrow. And as a more general warning, the fixed income ETF space is evolving such that the ETFs can be more liquid than what they own, which can cause the market value to stray from the fund's IIV (IIV is the ETF equivalent of NAV).

The reason to mention BulletShares at all is that they are now coming out with junk-bond funds with the same sort of maturity structure as the existing funds. I received a couple of emails on these that gave the impression that they would be out yesterday, but I don't think that was the case (no info on the Guggenheim website, and neither Yahoo Finance nor Google Finance recognized them).

Per the emails, there will be four junk-bond ETFs. The fund targeting 2012 will have ticker BSJC; 2013 will be BSJD; 2014 will be BSJE; and 2015 will be BSJF. The site for the index provider has information for underlying indexes going out every year until 2021, so perhaps there will be more funds later.

To be clear, the point of this post is not that you should run out and buy a junk bond ETF right away. Jeffrey Gundlach thinks now is a bad time for this space, but points out the space is evolving for the better.

The BulletShares concept, despite not getting a lot of attention, is actually one of the more important developments with bond ETFs, in my opinion. The bond market has been distorted by a combo of desperate policy and the fundamental risk currently embedded in the U.S. economy, and while I think the best way to navigate this problem is with a healthy dose of individual issues, not everyone is comfortable with this -- which is where funds can obviously come in.

We see precision with some funds in some segments, like lately with the TIPS space; with other segments, the maturities are a range of years, but it is the same number of years perpetually targeted. For example, a 7-10 year treasury ETF will always target 7-10 years, so if somehow the yield on a 7-year treasury was 6% today, buying that ETF would not lock in that 6%. If one year later a 7-year treasury is yielding 2%, then the fund you bought will be yielding something close to 2%.

The bullet share structure goes a long to minimizing that effect but -- and this is a big but -- if the 2016 fund yields 6% today but a bunch of cash comes in six months from now, requiring the purchase of more bonds, then the difference in rates six months from now could be significant enough to change your yield. I believe this is still a better way to go fund-wise ... but it's not perfect.