We been harping for some time now on Abnormal Returns about the fact that bond ETFs are not bonds. For some investors that is a somewhat confusing statement. As we note in a chapter on bonds in our book, Abnormal Returns: Winning Strategies From the Frontlines of the Investment Blogosphere, there are in fact very good reasons why bond funds exist. I wrote:
They allow smaller investors to diversify their holdings in a cost efficient manner. The market for individual bonds remains pretty hostile to the individual investor. Outside of Treasury bonds, transacting in the municipal or corporate bond markets is for all intends and purposes cost prohibitive. So from an investor’s perspective, a bond fund that provided diversification, lower transaction costs and a fixed maturity date would represent the best of both worlds.
First let’s ask why having a date-certain for the maturity of a bond or bond fund matters. Meir Statman in a guest post here wrote:
Holders of individual bonds have greater no-mental-loss benefits than holders of bond mutual funds since they have the option to wait till the maturity date of each of their individual bonds and receive what they have been promised. In contrast, holders of bond mutual funds have no such option since mutual funds have no maturity dates. The prices of mutual funds are set at the market price at the end of each day, moving up or down. Holders of bond mutual funds are never assured that they will not incur a loss when they sell, no matter how long they wait.
Now it seems that the concept of target-date bond ETFs is starting to really catch on. Jason Kephert at InvestmentNews* reports that the big ETF sponsor Blackrock is launching the iShares Corporate Bond Funds to complement their existing muni bond funds. Kephert writes:
Mark Weidman, global head of iShares, said he thinks target-date bond ETFs are one of the ways bond ETFs are going to catch up to equities, as they’re more like what the typical bond investor is familiar with…
“Fixed-income people don’t get ETFs,” he said at last month’s Morningstar ETF Invest Conference in Chicago. “We need to make them look more like a bond.”
Blackrock is not the first mover in this space but they are the biggest. It will be interesting to see how much they can move the needle on the adoption of target-date bond ETFs. Investors have been pouring money into general purpose bond mutual funds and ETFs since the onset of the financial crisis. If interest rates rise it will be interesting to see how well they withstand price drops versus those who have chosen to go the target-date bond ETF route.
*Hat tip to Brendan Conway at Focus on Funds who highlighted this news.