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Defined-Maturity Funds – The Answer To Your Bond Fund Needs

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In light of today’s low-interest-rate environment, I can understand an investor’s reluctance to owning traditional bond funds. After all, if interest rates across the bond universe were to rise significantly, many bond funds would take a noticeable hit. This may scare some investors into avoiding an allocation to bonds altogether, as is the case with Ruth Davis Konigsberg, who wrote Time.com’s October 20 article, “Why I Won’t Own Bond Funds in My Retirement Portfolio.” In her article, Konigsberg states the following:

“Once rates finally rise, bond prices will fall, which means investors will lose money. So when someone recommends diversifying one’s portfolio with bonds these days, I wonder: is there some kind of bond that’s immune to interest rate rises that I don’t know about?”

To see a list of high yielding CDs go here.

It’s a great question to ask, and one I would like to answer. If someone writing investing commentary for a widely-known publication such as Time is confused about bonds, I suspect there are plenty of other investors similarly confused.

First, let’s address the fact that the bond market is made up of more than just Treasuries. Those other parts of the bond market, such as corporate bonds and municipal bonds, trade at spreads to Treasuries. In economic environments in which the Fed is raising rates and Treasury prices are declining (yields rising), spreads in other parts of the bond market often narrow, offsetting some, and in some cases all of the rise in Treasury rates. My own portfolio of bonds has benefited from this effect in the past, with bond prices on several corporate issues actually rising over extended periods of time despite rising Treasury yields.

Furthermore, the slope of the yield curve and the time it takes for benchmark yields to rise play a role in determining whether you’ll experience price declines in your bond holdings. Additionally, floating-rate bonds are worth a look if you’re expecting a rising-rate environment in the near future. Just because you may be afraid of Treasury yields rising (prices declining), doesn’t mean all bonds are destined to decline in price. This is especially true with individual bonds.

Elsewhere in her article, Konigsberg mentioned, “I would love to find a bond fund that could be both a safe haven and could provide steady returns, but I just don’t think that exists anymore” [emphasis added]. While I think individual bonds are the best way to gain fixed-income exposure, if you are going to rely on bond funds, you should consider defined-maturity funds.

Defined-maturity funds essentially bridge the gap that exists between traditional bond funds and individual bonds. These funds exist until a pre-determined date, at which time they return capital to investors. They hold bonds maturing in certain calendar years, and generally hold those bonds until maturity. As the bonds mature, the fund transitions to cash and cash equivalents during the final months of existence. This structure helps investors manage interest-rate risk and should alleviate the concerns many investors have about what will happen to their principal, over the long run, in the event interest rates start to rise.

If, in addition to your principal, you’re also concerned about the low yields of today, you could consider one of the high yield defined-maturity funds, such as the Guggenheim BulletShares 2022 High Yield Corporate Bond ETF (BSJM). It currently yields over 5%. Guggenheim also offers several other defined-maturity ETFs, including the 2023 Corporate Bond ETF (BSCN), the 2024 Corporate Bond ETF (BSCO), and the 2021 High Yield Corporate Bond ETF (BSJL). Below, you will find the selection of other Guggenheim BulletShares ETFs (Source: GuggenheimInvestments.com).

Guggenheim-definted-maturity ETFs-1

In terms of defined-maturity municipal bond funds, Fidelity offers five. They include the Fidelity Municipal Income 2015 Fund (FMLCX), the 2017 Fund (FMIFX), the 2019 Fund (FMCFX), the 2021 Fund (FOCFX), and the 2023 Fund (FCHPX).

In closing, Konigsberg should be happy to know that indeed there are bonds that will act as if they are immune to rising Treasury rates, and that yes, there are bond funds that can still be both a “safe haven” and “provide steady returns.”

More from The Financial Lexicon:
The 5 Fundamentals of Building a Retirement Portfolio
Options Strategies Every Investor Should Know

 

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