They’ve been around since 2010 and BlackRock introduced four new ones in March, but so far, target date bond ETFs are still relatively unknown among investors and even financial advisors.
Their total assets are roughly $7.75 billion — or about four times the size of the average taxable bond mutual fund, and just a fraction of the roughly $3.3 trillion in bond fund assets, according to the Investment Company Institute.
“The level of awareness isn’t what you would think it is give the value proposition,” says William Belden, managing director for Product Development at Guggenheim Investments, which offers 18 target date bond ETFs.
But the relative anonymity of target date bond ETFs could fade when the financial markets become convinced that the Federal Reserve will finally make its move to raise interest rates for the first time since December 2008. At that point, yields on bonds — and bond funds — will rise and their prices, which move in the opposite direction of yields, will fall.
Before target date bond ETFs, there were “three ways to invest in bonds: buy an individual bond, a bond fund or a bond ETF,” says Stephanie Genkin, an independent fee-only financial planner based in Brooklyn, New York. And each way had its limitations, according to Genkin.
“If you hold an individual bond to maturity, you know what you’re getting back, and you know what the yield is,” says Genkin. “That might work in a rising environment, but you’ll need $25,000 to do anything. … What kind of pricing will you get?”
There is little transparency in the corporate bond market. The price investors pay depends on the institution that made the trade, and it will be buried in the bond yield. Unless a corporate bond is bought from the underwriter when the bond is issued, the price will be set in the secondary market by a dealer who will include his or her markup in the price of the bond. There is no fixed commission schedule.
Unlike individual bonds, bond funds and traditional bond ETFs never mature. Investors know the price they pay but the price — net asset value — will fall when rates rise so they could lose money, depending on when they bought the fund or ETF. “The manager of the fund or ETF will try to capture rising rates to pass on to investors, but investors won’t know what the value of the fund will be,” says Genkin. “They won’t know how much the NAV will fall.” Like bond funds and bond ETFs, target date bond ETFs hold multiple bonds, providing investors diversification that reduces risk.
“We’re trying to fill the gap between what investors get owning individual bonds and owing bond ETFs or funds,” says Belden.
Target date bond ETFs don’t have these limitations, though, like all investments, there are no guarantees. At this point only two companies offer target date bond ETFs: Guggenheim Investments offers 18 different BulletShares — 10 investment-grade corporate ETFs and eight high-yield corporate ETFs, with maturities ranging from 2015 to 2024 and total combined assets of $6.5 billion; and BlackRock offers 24 iShares iBonds — 18 investment grade corporate ETFs, including four that exclude financials, and six muni ETFs, with combined assets of $1.26 billion.
Each ETF owns bonds that mature the same year — hence, the target date — and within six months of the maturation of the ETF, which is usually at year-end, the ETF transitions into cash or cash-equivalent securities like U.S. Treasury bills. Unlike a bond fund, the manager is not constantly trading the portfolio.
When the ETF matures, the investor receives a final distribution similar to the principal repayment made when an individual bond matures. Before then investor receives monthly dividend payments, and those will decline as the ETF approaches maturity since cash and cash equivalents will pay less than the yield on the bond holdings.