It’s a tough world for folks living on a fixed income right now.
And the change was dramatic…
For about 40 years, bond investors felt like superstars. Interest rates moved relentlessly lower. And since bond prices move inversely to yields, that means they kept going up.
The long-term uptrend made buying bonds an easy win for investors. And it provided a safe bet for retirees looking for a steady income stream.
It’s different today, though…
Rates are rising and bond prices are falling. That isn’t what folks want to see in an asset class that was long considered a great way to reduce risk.
In yesterday’s essay, my colleague Karina Kovalcik covered the danger of relying on “pseudo bonds” – bond-tracking exchange-traded funds (“ETFs”) – in times like right now. She explained that it’s often worth taking the time to invest directly in actual bonds.
But sometimes, folks don’t want to put in the extra effort. So today, I’ll share another great option for investors looking to boost their exposure to bonds…
Yesterday, Karina described an important saving grace for bonds… They mature.
As long as the bond issuer doesn’t run into any credit problems, it will pay you in full on the agreed-upon maturity date. Capital losses only happen to those investors who sell their bonds in the secondary market before they mature.
But as Karina explained, this idea doesn’t apply to many bond-tracking ETFs. They never mature. So they’re essentially “pseudo bonds.”
For example, let’s say an ETF currently targets bonds with 20-year maturity terms. In 2037, those bonds will only have five years left until maturity.
The ETF can’t keep holding those bonds if it’s only holding ones with 20-year maturity terms. So it will need to constantly “rebalance” its holdings as time passes.
And in today’s world of falling bond prices, that means most bond ETFs are a losing game.
However, a certain kind of bond ETF offers an attractive option for investors…
I’m talking about “target date” bond ETFs. In short, these ETFs hold a basket of corporate bonds that mature in a specific year. And for the most part, these ETFs hold the bonds through maturity.
The Invesco BulletShares 2027 Corporate Bond Fund (BSCR) is a good example…
It began trading on September 27, 2017. And it’s scheduled to terminate on or about December 15, 2027.
By then, all of the ETF’s bond holdings will have matured. And the proceeds will be paid to shareholders. They’re expected to be about $20 per share.
This is important… It means target-date ETFs like BSCR don’t rebalance the way other bond ETFs do. They aren’t forced to regularly buy new bonds. Instead, they can just hold on to what they have and collect the bonds’ coupon payments.
And these target-date ETFs come with a couple of big advantages…
One advantage is diversification. That’s critical since you must accept corporate credit risk.
You see, these ETFs don’t hold U.S. Treasury bonds. They’re only available for corporate, high-yield, municipal, and emerging-market bonds. And these bond issuers could “default” on their debt at any given time.
To offset that risk, these target-date ETFs invest across a large number of holdings. For example, BSCR currently holds 303 bonds.
The other advantage is that these ETFs pay monthly dividends. Individual bonds only pay interest twice per year. So if you’re looking for a stable income stream, these target-date ETFs offer that. And remember, you’ll also get about $20 per share when the ETF is terminated in December 2027.
Now, I would be remiss if I didn’t mention a couple drawbacks for these target-date ETFs…
Long-term options don’t exist. The longest available target dates are 2031 for corporate and municipal bonds, 2029 for high-yield bonds, and 2024 for emerging-market bonds.
And unlike directly owning bonds, investors must pay expenses for owning these target-date ETFs. The expense ratios are 0.1% for the corporate ETFs, 0.18% for the municipal ETFs, 0.29% for the emerging-market ETFs, and 0.42% for the high-yield ETFs.
But the trade-off is well worth it… These target-date bond ETFs are a great option for investors who want to keep – or increase – their bond exposure in the currently tough fixed-income environment.
Even though rates are rising, you don’t have to give up on fixed income. You just need to move away from “pseudo bonds” and into better alternatives.
Good investing,
Marc Gerstein
