New Fixed Income ETFs Enable Do-It-Yourself Ladder

by Wayne Ferbert on May 21st, 2013

We advocate the use of Fixed Income ETFs for portfolios near and in retirement. In addition, we have recommended using fixed income ETFs for your excess cash. We have described the technique for pairing LQD & JNK with put options to modify your target returns while being hedged.
 
The reason we look to hedge the LQD and JNK is that these two ETFs maintain a set duration for the holdings in their funds. They ladder the ownership of the bonds and as bonds mature, they re-invest the funds back in to fixed income further out on the time curve such that they can maintain an average target duration for the overall portfolio.
 
The weighted average maturity for LQD and JNK is just shy of 12 and 7 years, respectively. The result is that interest rate moves will affect the price of the ETF in a material way. Just look at the move up in price for these two ETFs for the last several years. The reduction in interest rates has caused these ETFs to appreciate nicely.
 
When interest rates start to go back up again, the price of these two ETFs will certainly decline as the value of the underlying fixed income held in the laddered portfolio will start to decline.
 
The way to manage against this kind of price risk in your portfolio is to build your own laddered portfolio and hold to maturity to you can re-coup your investment principal. However, this is not an easy proposition for everyone – especially the smaller investor.
 
So, along comes iShares with an interesting new product launch of ETFs in early 2013. They have launched a series of Fixed Income ETFs with a targeted maturity date. All of the fixed income in the ETF mature within a 1 year window specified within each symbol. As the fixed income in the ETF mature, the fund will hold the money as cash and return it all to shareholders and terminate the fund once all of the fixed income pay off.
 
The series is the iSharesBond Corporate ex-Financials Term ETFs. They purchase fixed income issuances from investment grade companies – excluding financials. The symbols along with maturity year are IBCB for 2016, IBCC for 2018, IBCD for 2020, and IBCE for 2023. The team at iShares should be commended also for keeping the management fee for this ETF at only 10 basis points or 0.10%. That is exceptional!
 
Now, with these products, you can build your own ladder all the way out to 10 years. And if you decide to hold on to the fund all the way to maturity, you will receive the fair return of your capital based on today’s interest rates.
 
It is a creative way for the smaller investor to build their own laddered fixed income portfolio that they know is diversified.
 
Just one point of caution: these ETFs were just launched in April 2013 – so they are still small in volume. In fact, they tend to trade at a bid/ask spread that is a little wide for my tastes – and the result is that they trade at a premium to the NAV price. In a fixed income product in a low interest rate environment, you can’t afford to give up too much premium in the price when every little quarter point counts.
 
So, if you want to buy these, I recommend you hold out for the right price. Use the premium/discount calculator on the iShares web site and only look for a fill at a price you can feel good about.
 
I like the concept of a maturing fixed income ETF so that you can structure your own ladder. However, until the volume and AUM increases, you might want to wait on using these products.
 
Good luck!


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2 Comments

John - May 24th, 2013 at 6:25 AM
Would the Guggenheim Bulletshares offer a better value given that they have been around longer than the iShares product?
- May 24th, 2013 at 7:28 AM
John - What an excellent product find! I think too much of the market writes off the Guggenheim ETF suite but in reality they have grown nicely - and acquired Rydex along the way.

Guggenheim offers High Yield version also. I will profile these in Monday's blog!


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