iShares Term Bonds: Great Idea, Poor Execution

By Ron Rowland:

I have been a huge fan of target maturity bond ETFs since they first came on the scene in 2010. They combine the maturity date of individual bonds, the diversification of a mutual fund, the tradability of a stock, and the transparency of an ETF. Last week (July 10, 2013), BlackRock rolled out its newest lineup of term-structured corporate bond ETFs. They appear to be very similar to the four iSharesBonds ETFs introduced in April, although the earlier versions excluded issuers from the Financials sector.

As part of the recent overhaul of product names, BlackRock chose to distinguish the term-structured corporate bond ETFs from all other iShares ETFs by calling them iSharesBonds ETFs. For reasons unknown, BlackRock excluded all other bond ETFs, and even the iShares muni bond target maturity ETFs, from the new iSharesBonds designation.

According to the iShares website, one of the primary applications of bond ETFs that mature in a specific year is that “investors can construct a bond ladder using iSharesBonds.” I agree with this concept, but the new ETFs mature in years 2016, 2018, 2020, and 2023. This uneven spacing is where the execution starts to falter. Additional analysis follows the product descriptions.

• iSharesBond 2016 Corporate Term ETF (IBDA - News) tracks the Barclays 2016 Maturity Corporate Index of U.S. dollar denominated investment-grade corporate bonds maturing in the 12 months preceding April 1, 2016. IBDA has 173 holdings, an average yield to maturity of 1.23%, an effective duration of 2.25 years, and an expense ratio of 0.10% (IBDA overview).

• iSharesBond 2018 Corporate Term ETF (IBDB - News) tracks the Barclays 2018 Maturity Corporate Index of U.S. dollar denominated investment-grade corporate bonds maturing in the 12 months preceding April 1, 2018. IBDB has 183 holdings, an average yield to maturity of 2.33%, an effective duration of 3.86 years, and an expense ratio of 0.10% (IBDB overview).

• iSharesBond 2020 Corporate Term ETF (IBDC - News) tracks the Barclays 2020 Maturity Corporate Index of U.S. dollar denominated investment-grade corporate bonds maturing in the 12 months preceding April 1, 2020. IBDC has 126 holdings, an average yield to maturity of 3.27%, an effective duration of 5.16 years, and an expense ratio of 0.10% (IBDC overview).

• iSharesBond 2023 Corporate Term ETF (IBDD - News) tracks the Barclays 2023 Maturity Corporate Index of U.S. dollar denominated investment-grade corporate bonds maturing in the 12 months preceding April 1, 2023. IBDD has 195 holdings, an average yield to maturity of 3.83%, an effective duration of 7.67 years, and an expense ratio of 0.10% (IBDD overview).

Analysis/Opinion: Did you ever try to climb a ladder with a broken rung? How about one with more broken rungs than good ones?

A good ladder has its rungs evenly and predictably spaced. This new iSharesBonds series has three years to the first rung, two-year jumps to the second and third rungs, and then three years to the fourth rung. Furthermore, the fifth rung is undefined. We do not know if it will be a 2-year step, a 3-year step, or if 2023 is the end of the series. Whatever the answer, it is nearly impossible to have anything resembling a consistent ladder now, let alone when the 2016 ETF matures.

Another problem created by the iSharesBonds rung spacing is that this series only includes bonds maturing in four of the next 10 years, thereby excluding approximately 60% of all corporate investment grade bonds set to mature in the next decade. Do you really want to build a bond ladder from a universe that automatically excludes the majority of offerings just because of their maturity date?

Guggenheim BulletShares ETFs overcome all the problems with the iSharesBonds outlined above. BulletShares have one year between each rung of the ladder, do not eliminate bonds maturing in any years (let alone 60% of the years), and have clearly made their intentions known by allowing two funds (2011 and 2012) in the series to mature and extending the family with additional ETFs maturing in 2018, 2019, 2020, 2021, and 2022. Additionally, the average yield to maturity for the Guggenheim products tends to be about 0.3% higher than the corresponding iSharesBonds products, even though they have slightly higher (0.14% higher) expense ratios.

Disclosure covering writer, editor, and publisher: Long various BulletShares High Yield ETFs. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.