By: Michael Fabian, NASDAQ OMX Global Indexes Contributor
The volatility in interest rates this year has been particularly troublesome for fixed-income investors. Much of the jump in long-term Treasury bond yields has been due to the quicker than expected improvement in the labor market, thereby putting pressure on the Federal Reserve to begin tapering its asset purchase programs in 2013. The unrelenting rise in stock prices combined with investors pouring assets into equity-oriented funds at a breakneck pace has also put downward pressure on the fixed-income sentiment. This has been a wakeup call for investors to begin paying closer attention to their fixed income holdings, and examine them for potential weaknesses. Investors that own traditional “core” fixed income funds now face a unique set of challenges: continue to hang on as rates creep higher and indexes ultimately rotate to higher yielding bonds, or sell and forego the cash-flow benefit of fixed income altogether?
Investors that have a portfolio made up of individual bond issues have a very different set of concerns than holders of traditional bond funds. This is primarily due to the fact that a fund will continue its duration into perpetuity, as there is no fixed maturity date. It will simply roll short maturity holdings forward based on the investment objectives of the fund. Naturally the advantage to owning a fund is the ease of use and diversification you get for holding just one security within your portfolio. Conversely, the obvious advantages to owning individual bonds is the ability to latter a basket of credits, and then allow them to mature at par. This enables the investor to participate in the income component, yet not get wrapped up in the pricing anomalies in relation to treasury bonds. Furthermore, after maturity, you have the option of either rolling proceeds over to higher yielding bonds if a rising rate environment persists, or just sit in cash to wait out better opportunities.
Several years ago an innovative index-based ETF product was brought to market to satisfy the needs of both individual issue and bond fund investors. The Bulletshares concept is based on a “target-date” fund philosophy, but it utilizes a unique index methodology whereby bonds are grouped together based on their maturity date. As an example, the Guggenheim Bulletshare 2016 Corporate Bond ETF (BSCG) has a constituency of investment grade bonds that will all mature in 2016; when the fund is set to be liquidated at year end. As the bonds mature within the fund, the proceeds will be placed in cash until it finally liquidates and makes a full distribution to its shareholders. The index is inherently designed to represent a “held to maturity” basket of bonds with all the benefits of diversification offered by a fund.
A list of the Bulletshare family of ETFs includes options for both investment grade and high yield:
- Guggenheim BulletShares 2013 Corporate Bond ETF (BSCD)
- Guggenheim BulletShares 2014 Corporate Bond ETF (BSCE)
- Guggenheim BulletShares 2015 Corporate Bond ETF (BSCF)
- Guggenheim BulletShares 2016 Corporate Bond ETF (BSCG)
- Guggenheim BulletShares 2017 Corporate Bond ETF (BSCH)
- Guggenheim BulletShares 2018 Corporate Bond ETF (BSCI)
- Guggenheim BulletShares 2019 Corporate Bond ETF (BSCJ)
- Guggenheim BulletShares 2020 Corporate Bond ETF (BSCK)
- Guggenheim BulletShares 2021 Corporate Bond ETF (BSCL)
- Guggenheim BulletShares 2022 Corporate Bond ETF (BSMC)
- Guggenheim BulletShares 2013 High Yield Corporate Bond ETF (BSJD)
- Guggenheim BulletShares 2014 High Yield Corporate Bond ETF (BSJE)
- Guggenheim BulletShares 2015 High Yield Corporate Bond ETF (BSJF)
- Guggenheim BulletShares 2016 High Yield Corporate Bond ETF (BSJG)
- Guggenheim BulletShares 2017 High Yield Corporate Bond ETF (BSJH)
- Guggenheim BulletShares 2018 High Yield Corporate Bond ETF (BSJI)
Practical uses within a portfolio can vary, and include the basic buy-and-hold to maturity approach, or even a more sophisticated yield curve positioning strategy. Other uses can even include opportunistically shortening or lengthening duration, while staying in the same fund family to take advantage of prevailing interest rate fluctuations.
When the need arises for even large institutional portfolio managers to target a specific duration and/or credit quality within their portfolios, Bulletshares ETFs offer the convenience of not having to curate an entire bond latter from scratch. This concept opens up the use of Bulletshares to small or medium sized pension funds or defined benefit plans to cut the cost of research and implementation.
With the future of interest rates largely being called into question, investors need to leverage every tool they can to protect capital while still generating income. Reaching outside the bounds of your typical core fixed income fund can have many benefits. However, understanding the risks associated with market price fluctuation, while still having the defined maturity to fall back on is something many investors should take heed to.
Note: As of this writing, the author did not own any securities listed in this article.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.
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