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A Look Inside Defined Maturity Bond Funds

Investors have increasingly embraced fixed income ETFs, favoring their low-cost structure, ease of use, targeted exposure and diversification, explains Todd Rosenbluth, analyst with CFRA Research's The Outlook.

Such traits can be easily exemplified with the popularity of target maturity indexETFs. Generally, these funds own a diversified portfolio of bonds that mature or are anticipated to be called in a specific year. Once the ETF’s maturity date is reached, all the net assets are returned to shareholders and the ETF is discontinued.

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These portfolios combine the benefits of bonds — final distribution at maturity, yield and credit quality — with the advantages of ETFs — broad diversification, liquidity, transparency, convenience and cost-effectiveness, and in combination can be used as a one step process for bond laddering, making them a potentially useful tool for planning for a specific event — perhaps college tuition for a child or grandchild or even funding healthcare costs in a pre-65 retirement.

The iShares division of BlackRock (BLK) and Invesco (IVZ) each offer a suite of investment-grade corporate bond ETFs focused on the upcoming calendar years. The two firms also offer targeted high-yield and municipal bond products.

Maturity dates on these products range from 2019 to 2028. (Although the companies have not yet said, it’s a relatively safe assumption they will continue to offer new products for future years. By purchasing, say, ETFs maturing in three, five, seven and 10 years, one has built a bond ladder.)

The 2021 vintage of these ETFs has been among the most popular, particularly as interest-rate sensitivity remains heightened. The four 2021 target-maturity bond ETFs we highlight had $1.26 billion of net inflows since the beginning of 2018 and now have $3 billion in net assets.

Invesco BulletShares 2021 Corporate Bond (BSCL) is the largest of the four relevant ETFs with $1.25 billion in assets, but iShares iBonds Dec 2021 Term Corporate (IBDM) is also sizable with $945 million.

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Let's first focus on the comparison of these two. Given the similar maturity profile, both ETFs have an average duration of two years and sport a 3.4% 30-day SEC yield. However, there are differences from a credit perspective.

Using S&P Global Credit Ratings, BSCL has more exposure to A-rated bonds (42% vs. 39% for IBDM) and less exposure to BBB (43% vs. 45%). Although CFRA does not think investors should rely solely on a three-year track record to review ETFs, BSCL was the stronger performer as of January 23, with a 2.89% annualized total return (2.60% for IBDM).

This stems from the exposure as, for much of the time, the iShares product had a lower fee. However, Invesco acquired these BulletShares products in the Guggenheim acquisition in April 2018 and cut the fee for the investment-grade suite. BSCL and IBDM now both have a 0.10% net expense ratio.

We had expected that target maturity ETFs were more likely used by investors to buy and hold to maturity, rather than as tactical trading vehicles. Yet, due in part to steady inflows, BSCL and IBDM trade, respectively, approximately 475,000 and 290,000 shares daily. Both have tight penny bid/ask spreads. Both are effectively buy-and-hold-until-maturity investments; IBDM's annual turnover is 6%, while BSCL's is 7%.

For investors seeking a higher yield but a similar targeted maturity, Invesco BulletShares 2021 High Yield Corporate Bond ETF (BSJL) is also good option.

This $555 million ETF has an elevated 6.3% 30-day SEC yield, due to its exposure to BB- (45% of assets) B- (46%) and CCC-rated (7%) bonds; for perspective, Invesco Fundamental High Yield Corporate Bond (PHB) has a 5.4% yield with more BB exposure (62%) and less B (23%).

BSJL charges a 0.42% net expense ratio that is higher than BSCL and IBDM but does not face the same competitive pressure because it's the only 2021 high-yield target maturity ETF. BSJL trades with a wider bid/ask spread than its 2021 peers, but average volume has recently exceeded 200,000 shares/day.

Lastly, iShares iBonds Dec 2021 Term Muni Bond (IBMJ) is the smallest of these low duration ETFs with $255 million in assets. The ETF provides strong credit quality with most bonds rated AAA (38% of assets) and AA (49%).

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