There's A Place For Bond ETFs With A Defined Maturity

Includes: BSCH, BSJF
by: Drummond Osborn

The long bull market in the bond arena has solidified my aversion to bond mutual funds. Though many shareholders did benefit from, and became accustomed to, net asset value (NAV) appreciation, I can applaud these funds' diversification, understand the argument for active management, but fear with all my heart the erosion on NAV when rates begin to tick up. And while dividend paying stocks and dividend focused ETFs are my preferred mechanism for portfolio income, there is still a place for some fixed-income in most portfolios.

While attending the ETF Virtual Summit earlier this year, I was introduced to the ETF offerings of Guggenheim Investments . But it wasn't until an older client asked me to pick up a bond for him that I dug in for deeper research - after all, finding meaningful yield is no easy task. What drew me to this small stable of fixed-income ETFs were their fund offers with a defined-maturity exposure. Unlike actively managed mutual funds with portfolio turn-over, higher expense ratios and changing dividend streams, or typical bond ETFs which rotate holdings based on the applicable index, the Guggenheim bullet-shares are designed with a finish line in mind. Shareholders know when they will receive a payout of the funds' NAV.

Guggenheim's bullet share funds, as an alternative to individual bonds, offer the diversification and liquidity of other ETFs but provide the defined-maturity date which typical ETFs and mutual funds can't give their shareholders. In order to avoid submitting to pure yield chasing, consider combining the Guggenheim BulltetShares 2017 Corporate Bond (NYSEARCA:BSCH) with the Guggenheim BulletShares 2015 HighYield Bond (NYSEARCA:BSJF). As of 3/23/12, the 12-months yields were 3.29% and 5.56%, respectively. But yield for yield's sake can be investor folly. Take a look at the Guggenheim site for the deeper research investors need before committing real cash. By clicking on the Yield tab, under Yield & Performance, you'll find that BSCH maintains a yield-to-maturity and a yield-to-worst of 3.04%. With no calls and solid credit ratings, this provides a sense (though no guarantee) of what investors might expect. Investors need to be fully aware of the effect the fund's Premium/Discount will have on total return, and make sure not to hand over too significant of a premium. Use of limit orders is a must to control purchase pricing. All fixed-income investing suffers from interest rate and inflation risk, but since the BSCH portfolio closes out at the end of 2017, the interest rate and inflation risks are minimized.

The BSJF should be approached like any high-yield option, which is why I considered a shorter defined-maturity date - equating to less time for bad surprises to happen. Potential investors should not be drawn into the position by its 12-month yield of 5.26% or its yield-to-maturity of 6.43%, but instead should conservatively target and understand the yield-to-worst of 5.04%. High-yield bonds are high-yield for a reason, and investors must understand and be accepting of their default risk. Combining these two funds blends investor yield, risk and access to capital.

Investors and advisors, alike, have been surprised that interest rates have stayed - and are projected by the Fed to remain - low. Not knowing when rates will begin to rise should keep astute investors concerned about eroding bond prices, and has trapped many such bond investors on the sideline. For those folks, the Guggenheim defined-maturity ETF offerings may be one satellite solution for fixed-income exposure.

Disclosure: I am long BSCH, BSJF.

Disclaimer: The above article has been written utilizing data from publicly available sources, which are believed to be reliable, and is provided for informational and educational purposes only. Investors should consider their personal situation and become intimately familiar with any investment, including its prospectus, before investing. Past performance and current yields are no guarantee of future results.