A New Way To Play Target Maturity Bond ETFs

by: Matt Tucker, CFA

Almost a year ago today, I wrote a post about the 10-year anniversary of the first bond ETF – the iShares iBoxx $ Investment Grade Bond ETF (NYSEARCA:LQD). I briefly recapped what had happened since that launch, from the slow and steady growth of investor usage of bond ETFs to the growing understanding that this "experiment" had worked. I concluded the post by posing the question, "What's next for fixed income ETFs?" While I think there are a number of answers to that question, one trend in particular has caught my eye as the "next thing" in this category: target maturity bond ETFs.

So what is a target maturity bond ETF? It's pretty much exactly what it sounds like – an ETF that is a portfolio of bonds that mature within a specified year, say 2016 or 2018. Unlike a traditional fixed income ETF, which targets a maturity range, a term bond ETF will actually mature at a specified date, at which point investors receive a final distribution. In this way, it feels very similar to investing in an individual bond.

We pioneered the target maturity bond fund structure in 2010 with the launch of a series of municipal bond funds. We broadened our offering this past April, with the iSharesBondTM Corporate Term ex-Financials ETFs. More recently, we expanded the lineup even further with the launch of iSharesBond Corporate Term ETFs:

  • iSharesBond 2016 Corporate Term ETF (NYSEARCA:IBDA)
  • iSharesBond 2018 Corporate Term ETF (NYSEARCA:IBDB)
  • iSharesBond 2020 Corporate Term ETF (NYSEARCA:IBDC)
  • iSharesBond 2023 Corporate Term ETF (NYSEARCA:IBDD)

We have seen growing interest in the term maturity ETF structure, with assets now over $600 million, according to Bloomberg data. Investors are using these funds to create custom fixed income portfolios, much the same way they use individual bonds. For example, investors can use target maturity bond ETFs to complement an existing bond ladder or to build one from scratch. Because iSharesBond ETFs are diversified, they can help mitigate default risk. And because they trade intraday on the exchange, investors can easily see available liquidity and price.

Also like an individual bond, target maturity ETFs have a finite investment horizon. An investor is exposed to less and less interest rate risk over time as the fund approaches maturity. This feature may be especially appealing to investors who are drawn to individual bonds due to concerns about potential rising interest rates.

For these reasons, we would expect target maturity funds to play a bigger role in the fixed income ETF space as investors become more familiar and more comfortable with how they work.

Bonds and bond funds will decrease in value as interest rates rise and are subject to credit risk, which refers to the possibility that the debt issuers will not be able to make principal and interest payments. Narrowly focused investments typically exhibit higher volatility and are subject to greater geographic or asset class risk. Shares of the Fund trade at market price, which may be greater or less than net asset value.

The iSharesBondTM ETFs ("Funds") will terminate on or about March 31 of the year in Fund's name. An investment in the Fund(s) is not guaranteed, and an investor may experience losses, including near or at the termination date. In the final months of the Fund's operation, as the bonds it holds mature, its portfolio will transition to cash and cash-like instruments. Following the Fund's termination date, the Fund will distribute substantially all of its net assets, after deduction of any liabilities, to then-current investors without further notice and will no longer be listed or traded. The Funds do not seek to return any predetermined amount.

During the 12 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.

The rate of Fund distribution payments may adversely affect the tax characterization of an investor's returns from an investment in the Fund relative to a direct investment in bonds. If the amount an investor receives as liquidation proceeds upon the Fund's termination is higher or lower than the investor's cost basis, the investor may experience a gain or loss for tax purposes.

Diversification does not promise any level of performance or guarantee against loss of principal. When comparing investments in bonds and iShares Funds, it should be remembered that management fees associated with fund investments, like iShares Funds, are not borne by investors in individual bonds.

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