Junk bonds, however, mature at different times during a fund’s maturity date year. What’s more, a large percentage of them are callable (companies like to refinance their debt if rates go down or if they otherwise become more solvent or creditworthy). Because they can be called, they’re an odd fit with the defined maturity structure, to the point some asset managers don’t consider them to be a suitable asset class for this product. BlackRock, for example, declined to create defined maturity bond funds with high yield in them.
Guggenheim’s BulletShares funds hold a small number of bonds with longer maturities than the funds’ stated maturity dates to compensate for the bonds’ call features. Yet here there’s a risk the bonds will mature after investors expect their money back, and funds have to strike a balance between the risk of a call and the risk of later maturities. Currently, the average maturity of the Guggenheim BulletShares 2024 High Yield Corporate Bond ETF (BSJO) is around 7 years. That’s about six months shorter than the fund’s December 3, 2024, maturity date.
Along with the structural problem of callable bonds in a defined maturity wrapper, high-yield investors need to consider the loss rates for these products. Guggenheim’s 2024 fund currently has a distribution yield of 4.68%. And while that represents a 2.5 percentage point yield spread over a 10-year U.S. Treasury, 2.5 percentage points is roughly the historical loss rate suffered by high-yield bonds, considering their 4.2% default rate and 40% recovery rate. In other words, if junk bond loss rates resemble those of the most recent 25 years or so, junk bond investors would make a loss-adjusted return that’s almost identical to that of a 10-year U.S. Treasury right now. If loss rates spike up beyond the historical average during this cycle, junk bond investors will make less than they would have in Treasurys.
Because junk bond defaults and losses occur in pronounced cycles, investors tend to forget about them when things are calm. Currently, junk bonds offer little or no reward for the risk they present to investors, regardless of the vehicle used to own them.
The issue of junk bonds aside, investors considering these types of bond ETFs should note that PowerShares has two funds that contain laddered portfolios. One is the PowerShares LadderRite 0-5 Year Corporate Bond Portfolio (LDRI), which tracks an equally weighted, short-term investment-grade corporate bond index. The fund, in accord with its index, equally weights bonds that mature in each of the next five years. When bonds mature, the fund will reinvest the proceeds in bonds that cause the fund to continue to track the index. The PowerShares 1-30 Laddered Treasury Portfolio (PLW) operates similarly with regard to the U.S.
Treasury market, equally weighting maturities of up to 30 years. If a bond isn’t available to the fund’s underlying index, the index will overweight the bonds on either side of the unavailable bond until it becomes available.
Ultimately, these PowerShares funds are more like traditional bond funds because they don’t have maturity dates. They mimic a yield curve by laddering maturities more than they serve as the rung of an investor’s bond portfolio. Instead of allowing investors to build a ladder, these funds serve as the entire ladder themselves—but without the certainty of having money come due directly to the investor on a particular day.
Overall, target maturity bond ETFs are useful tools for building bond ladders. They provide diversification and some insulation from the credit risk of owning an individual bond at a particular maturity date that laddered portfolios wouldn’t have otherwise. But investors should note that the call features of bonds and the random maturity dates within a given year cause these ETFs to get lower yields in their last year than people might realize. There’s always a price to pay for greater safety or increased insulation from credit risk.
John Coumarianos, a former Morningstar analyst, is a financial writer in Laguna Niguel, Calif.