Investors can lock in yield in these unique assets as Fed likely lowers rates
Investors looking to lock in yields and maintain a steady stream of income may consider buying defined-maturity exchange-traded funds. The products have grown in popularity in recent years as the Federal Reserve raised interest rates, and experts believe they’ll be a place investors will turn to as those rates move down — especially those who have had been holding a lot of cash . The market is currently pricing in about 88% odds of a rate cut at the Fed’s meeting this week, according to the CME FedWatch tool . Defined-maturity funds provide diversity like traditional ETFs, yet unlike those standard vehicles they have maturities and liquidate like a bond. Investors simply choose an ETF that holds bonds that all mature in a specified year. “Instead of buying one bond at a time and only owning a few bonds in your investment account, you get the diversification of owning hundreds of bonds,” explained Jason Bloom, head of Invesco’s fixed income ETF strategy. The ETFs essentially look to mimic individual bond behavior. When the ETF matures, the investor is paid out and can either pocket the money or reinvest. They can also be laddered, which is essentially buying varying bonds or ETFs of staggered maturity dates. Yet funds are easier for retail investors to access than bonds — they can be purchased on the stock exchange and investors don’t have to do the legwork that’s required when buying bonds. Gaining in popularity Investors have poured $46 billion into the target maturity ETF category over a trailing three-year period ending in November, according to Morningstar. At BlackRock, its iBond suite of defined maturity bonds has seen its net assets balloon in the last three years from about a $10 billion product set to nearly $40 billion, said Karen Veraa-Perry, head of BlackRock’s iShares U.S. fixed income strategy. The firm offers more than 50 products spanning across corporate, municipal and high-yield bonds, as well as Treasurys and Treasury Inflation-Protected Securities (TIPS). Veraa-Perry said now is the ideal time to add some duration and lock in yields as the rates of cash-equivalent assets come down. While the Fed won’t drop rates too low, she expects they will move to a 3% range in the next 12 months. In comparison, BlackRock’s most popular ladder of one- to five-year corporate iBonds is yielding about 4.2%, she said. “If you can get 4.2% consistently over the next five years, as opposed to having your rates drop down to 3 [%], we think that that is compelling for a lot of investors,” Veraa-Perry said. Invesco’s Bloom sees opportunity in the two- to three-year part of the curve for corporate bonds, and eight to 10 years for municipal bonds. He also believes there’s a significant risk that the curve will steepen more. With the Fed not expected to move shorter term rates significantly lower, the back end of the curve “might have to do some work,” he said. Bloom doesn’t see the 10-year Treasury yield going below 4%. “With BulletShares, people have a chance to be really precise in their yield-curve exposure in a way that they don’t in most other fixed income funds, ETFs or mutual funds,” he said. “It allows people to really dial in that risk-reward between duration and yield, and they can continue to adapt right as a macro environment adapts.” Invesco’s BulletShares have just under $28 billion in total assets. Laddering to avoid rate volatility The big benefit to laddering varying maturities of defined-maturity ETFs is that investors make themselves immune from interest-rate volatility, said Saraja Samant, an analyst with Morningstar’s fixed income manager research. If interest rates fall, then any reinvested principal investors put to work after an ETF matures will not earn as much, she said. However, “at least the bonds that are there in the ladder that you have invested in today will be earning higher rates now, as compared to the bonds available in the market,” she explained. “So the bond ladders can be useful in either situations, whether the interest rates are rising or the interest rates are falling.” Defined maturity vs. traditional bond ETF Deciding between a defined-maturity ETF versus a traditional one comes down to several factors. “If you’re an investor who has a long-term time horizon and you just want to be invested in a fixed-income asset class, I think our regular ETFs that don’t have maturity dates, they function very well,” Veraa-Perry said. “They’re low cost. They give you diversification. You can kind of set it and forget it.” However, those with a specific time horizon may want to consider a defined-maturity fund, she said. That could mean someone saving for college or a person looking for a place to park required minimum distributions from individual retirement accounts or 401(k)s. In addition, some people like deciding what to do with their money once maturity is reached, she added. “We have people who like the bond laddering concept, because they don’t really have to bet on interest rates. They’re locking it in, and then each year they can just go out and term it out,” Veraa-Perry said. “It just depends on how you think about fixed income.”
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