Why Laddering Bond ETFs Works Right Now

October 02, 2014

Forget perpetual bond ETFs—a laddered strategy might be just what you need in this rising-rate environment, Gradient Investments’ Wayne Schmidt says.

If interest rates do rise in the next year or two, laddering a bond portfolio could prove to be an effective way of managing duration risk while collecting a somewhat-predictable income. That’s in essence what Wayne Schmidt, chief investment officer of Arden Hills, Minnesota-based Gradient Investments suggests.

In his view, a laddered bond portfolio helps investors fill income gaps, and meet cash needs in a way that perpetual bond funds don’t allow. His firm—a third-party money manager that manages some $640 million in assets today—has turned laddering with Guggenheim’s BulletShares suite of target-date bond ETFs into a centerpiece of its approach to fixed income.

Schmidt tells ETF.com why laddering works, how to go about it and what risks you need to fully understand before jumping in.

ETF.com: BulletShares ETFs now cover eight years of high-yield and 10 years of investment-grade exposure in the corporate bond space. That’s basically access to the full spectrum of the curve in corporate bonds. Is that the right way to look at the BulletShares suite?

Wayne Schmidt: That would be a fair way to look at it. The way we use it is we're building three-, four- and five-year ladders, so we haven’t gone out that far. But it’s nice to have product if somebody wants that.

Our investors are primarily going into a three-year ladder—that’s the most popular—because they are of the belief that interest rates are going to rise. In the three-year ladder, you're getting money back to reinvest at higher rates a year or so from now.

ETF.com: These portfolios essentially work like a single bond would. What's the breadth of what you can do with these types of ETFs?

Schmidt: I was an institutional fixed-income manager, so I worked with individual bonds all the time before. But what I find is the retail investor doesn't have enough assets, enough quantity of wealth to diversify properly. What's great about the Guggenheim ETFs, and ETFs in general is that individual investors can get the diversification that they need.

Within one of those ETFs, let’s say the 2015 high-yield Guggenheim fund [Guggenheim BulletShares 2015 High Yield Corporate Bond ETF (BSJF | B-68)], they’ll own 250 different individual bonds in that portfolio. When you're talking credit risk, it’s great to have numbers. And to have 250 issuers in one ticker, that’s beneficial to the individual investor.

ETF.com: Why ladder a bond portfolio?

Schmidt: A lot of individual investors have different needs for cash, and the one nice thing about laddering is that it has a maturity. In the past, you could only do that with individual bonds.

Say you're a parent or grandparent, and you want to save for a child’s or a grandchild’s college. You know you have this liability that's going to be paid out in a four-year period, but you don't want to risk a lot of your principal, so a four-year ladder is a great example of how you can structure it so that you get your funds back over that four-year period.

We've had clients come in where they’re taking care of a parent who now needs assisted living. All of a sudden, they had an investment portfolio but now they needed to get cash on a regular basis to pay for the assisted living. It’s nice knowing that you know when that cash flow is going to come back to you with some sort of certainty. Yes, there’s default risk and things like that, but you at least know the date.

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