Why Bond Laddering ETFs Works

October 06, 2015

Bond laddering with ETFs is still a relatively novel concept in the ETF space that is slowly but surely getting traction with investors who are looking for ways to manage duration risk in a rising-rate environment.

Guggenheim and iShares have extensive lineups of target-date bond ETFs today that allow for customized ladders in both the investment-grade and high-yield spaces. We’re talking about funds such as the Guggenheim BulletShares 2017 Corporate Bond ETF (BSCH | B-52), the Guggenheim BulletShares 2017 High Yield Corporate Bond (BSJG | B-66) and the iShares family of iBonds ETFs—like the iShares iBonds Mar 2020 Corporate ETF (IBDC | C-72).

Invesco PowerShares, too, has an interesting take on the theme, with the PowerShares LadderRite 0-5 Year Corporate Bond ETF (LDRI | C). LDRI is an equally weighted short-term investment-grade corporate bond index, resulting in a bond ladderlike portfolio.

As the Federal Reserve hints of an upcoming interest rate hike, these bondlike funds are useful tools for investors looking for predictability of income, said Matt Forester, chief investment officer at Newtown Square, Pennsylvania-based NewSquare Capital. Forester tells us why he likes bond ladders and how he is using them.

ETF.com: Where do you see opportunities, or concerns, in fixed income right now? Give me your big picture.

Matt Forester: There has been a lot of concern in credit and high-yield credit lately. We've been reducing exposure to credit risk in the portfolios we manage for the better part of the last year and a half or so. I think it's just a spread trade. You’re just not getting paid a whole lot to own some of that paper.

Obviously, the spreads have really widened in all kinds of areas of the market due to the energy price collapse and concerns about global markets. There’s also a cyclicality to these markets that’s impacting junk bonds.

But in a broader sense, finding opportunities in fixed income and managing fixed-income positions has become a lot more difficult for a lot of retail players and smaller advisors, especially since the financial crisis made trading big pieces of the market a lot harder. To me, it’s newer types of ETFs—I’m thinking about BulletShares and ladder-type funds—that offer a great opportunity for investors and advisors to manage their fixed-income positions.

ETF.com: In the context that the Fed has suggested it will raise rates before the end of the year, are investors better off owning perpetual bond funds or a laddered bond strategy?

Forester: The ETF ladder concept has real advantages. Now, let me first admit to a lot of skepticism about the Fed's ability to raise rates here. Clearly, that's what's going through the markets right now, but I don’t believe it will happen. Keep in mind that the Japanese central bank took its policy rate down below 50 basis points 20 years ago, and have not been able to raise it since. It’s still not able to get out of this very-low-interest-rate environment.

The Fed wants to raise rates; it would love to normalize policy. But we'll see whether they're actually able to do that.

That said, these ladder bond funds are a better way to manage your portfolios if you're wrong about the rates rising to some degree. We customize ladders, actively managing duration and yield maturities across the ladders, managing the exposure to risk.

ETF.com: The idea here is that, by laddering, you can have more control over your duration exposure as opposed to that of a perpetual bond ETF?

Forester: Exactly. I don't think most people understand how the general bond ETFs function, in that they have a target maturity and duration zone, but as time moves on, that keeps moving ahead, because the index itself has to keep adding on longer-duration issues to maintain the duration of the fund within their target.

Whatever the index is, they have to maintain that to the index, whereas the BulletShares or the ladder funds are able to ride down the curve.

And in an environment where the yield curve is still relatively steep—it's certainly flattened a lot over the last few months as we've been concerned about economic growth issues—it’s beneficial to ride down the curve to capture total returns.

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