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Rise of Defined Maturity ETFs in Bond Investing

Investors seeking higher yields are turning their attention to a lesser-known type of bond fund called defined-maturity exchange-traded funds (ETFs). These funds have recently gained popularity due to their similarities to individual bonds, as they reach maturity and are liquidated on a specific date. Major providers of these funds, such as BlackRock and Invesco, allow investors to enjoy the advantages of purchasing a single bond while still benefiting from diversification and easy trading. The funds hold a diversified portfolio of bonds that mature close to the fund’s maturity date, with any holdings maturing before that date often placed in cash-equivalents held by the fund. On the maturity date, the fund’s shares are liquidated at their net asset value, resulting in the proceeds being paid to investors as a distribution. An example is BlackRock’s iShares iBonds Dec 2033 Term Treasury ETF, which tracks an index of Treasurys maturing in 2033 and holds a portfolio of three U.S. Treasury notes. The effective yield to maturity for investors buying this fund now is around 4.7%, higher than the average coupon of the notes held by the fund, due to rising yields and the fund’s share price decline since launch.

Defined-maturity ETFs are particularly popular because investors can use them to construct bond ladders, which involves purchasing bonds with staggered maturities, and reinvesting the proceeds into new bonds as each bond matures, thus achieving a specific yield over a predetermined period. This approach requires additional effort compared to holding a fund, but it helps lock in desired yields and reduces the risk of being trapped in a bond fund affected by rising interest rates. Furthermore, the recent volatility in bond markets, exemplified by the fluctuation in benchmark 10-year Treasury yields, has increased the appeal of these funds that offer the possibility of locking in a particular yield. Moreover, financial advisers are also using defined-maturity ETFs to establish bond ladders for their clients, as it simplifies the process compared to purchasing individual bonds typically aimed at institutional investors; and in terms of cost, these funds are attractive, with fees as low as 0.07% annually for Treasury bond funds from BlackRock and 0.1% for investment-grade bond funds from Invesco. Overall, defined-maturity ETFs have emerged as a viable option for investors seeking higher yields while maintaining diversification and flexibility in their bond portfolios.

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