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Defined-Maturity Funds: A Bond Alternative With Compromises

by Charles Rotblut, CFA

Defined Maturity Funds: A Bond Alternative With Compromises Splash image

Defined-maturity funds are hybrid funds designed to bridge one of the biggest gaps between traditional bond funds and individual funds.

As the name implies, defined-maturity bonds cease their existence on a specified date. At maturity, investors receive a distribution equivalent to the fund’s net asset value. These funds are intended to be a solution for investors who desire certainty over the timing of cash flows or wish to stagger their interest rate exposure, but do not want to invest in individual bonds. Since these are funds, however, they come with compromises that should be understood and considered before purchase.

The complexities lie not only in the structure of the funds themselves, but also in the differences between bonds and bond funds. Understanding how these two differ helps to better understand the role defined-maturity funds can play in a portfolio.

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Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at twitter.com/charlesrotblut.


Discussion

Patrick Gariety from Missouri posted 6 months ago:

Thanks much for this article! I don't wish to purchase individual bonds, but I've been seriously considering defined maturity ETFs/funds as an alternative way of capturing some of the benefits of a bond ladder. Your article was very helpful in clarifying the available options and their differences.


Tim Soles from Texas posted 6 months ago:

Good article. I have the Guggenheim ETFs in my IRA portfolio (at Fidelity) and, for me, it is a way of extending risk into high yield bonds while minimizing the risk of default and thereby obtaining higher yields at the lower risk due to maximum diversification in this bond class.


Lew Marks from Oregon posted 6 months ago:

I think these investment vehicles give you most of the best of both worlds:
1. Defined maturities
2. Good bond picks at good prices

Ever try to pick your own bonds and get a decent price. The big boys give you the left-overs at higher prices and commissions.

Time will tell, but, so far, I like these products.

Lew


Victor Bradford from Colorado posted 6 months ago:

Thank you for the excellent article and the suggested investment resources.
I have also investigated defined-maturity investments and individual bonds, and perhaps the greatest benefit of the former is the diversification these investments allow (I have the benefit of humility, since I nearly invested in General Motors bonds back when they were rated in the B category).
Nevertheless, the article may have overstated some differences between bonds, bond funds, and defined-maturity investments. Brokerage houses often buy large lots of some bonds, so smaller investors may also receive some pricing benefits of large-lot purchases. You can indeed suffer tax consequences and capital losses from all bond vehicles depending on when you sell them, or when your estate sells them (if the bonds are sufficiently long term). A "perpetual" bond ladder actually resembles a bond fund in many ways. Finally, even when buying individual bonds from a broker, you often wind up relying on their advice (or that of the rating agencies), too, unless you are quite experienced or hubristic.


Mike Timlin from Colorado posted 6 months ago:

I am late and new to fixed-income investing, but I still have time to get ready for retirement, so now is the time to learn.

When I heard about these late in 2012, I decided to 'run the experiment'. So, I bought equal quantities of each of the BSJD through BSJI in the first half of 2013.

So far, in spite of all of the Fed-induced turmoil, the experiment has been a great success. The BulletShares High-Yielders have been magnificent. The blended payout has been about 4.5%. The capital gains have been a nice surprise, as I'm a low-cost buyer. The volatility has been trivial.

Note that these funds are high-coupon (~8%) and short-duration (~4 years or less), which I like.

I plan to roll over the BSJD when it matures into BSJJ, and I may roll over the BSJE to BSJK, if I can get a good prices.

Everybody should own some of these products, in my opinion.


Judith Boulden from Utah posted 5 months ago:

Shortly after purchasing MUAE - iShares 2016 AMT-free Muni series, I noted unusual volatility in price in late May and early July, 2013. The usual price is about 53.50 and this activity went from a low of about 52.25 to a high of 54.55 and back again within a couple of days. Was it a "flash crash" technical issue, or, more importantly, are these EFT's so thinly traded that a large transaction can impact the price this much? Any information or comments would be appreciated.


Charles Rotblut from Illinois posted 5 months ago:

Hi Judith,

The price movement you are discussing is about 4.5%, which over the course of few days can simply reflect market volatility. Interest rates spiked over the summer and impacted the prices of both bonds and bond funds.

The fixed-maturity funds are designed to be held until maturity. The day-to-day price movement doesn't matter much once you hold the fund because the proceeds from the underlying bonds will be paid to shareholders after the bonds mature.

-Charles


Russell Pettijohn from Missouri posted 5 months ago:

How much dividend and yield?


Judith Boulden from Utah posted 5 months ago:

Hi Charles,
I realize that, but would you look at the price chart? It looks odd to me to have that spike.


Scott Davis from Maine posted 4 months ago:

Thanks Charles - enjoyed your talk at the conference in Orlando


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