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Guggenheim Explains How to Bring Flexibility to A Fixed Income Portfolio


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By William H. Belden

Guggenheim Investments is one of the nation’s top ETF providers. The firm is recognized as an innovator in the industry, as exemplified through its launch of the first defined maturity corporate bond ETF suite, Guggenheim BulletShares®, and its launch of the industry’s first alternatively weighted ETF strategies. The following is an overview of BulletShares, as well as a look at the flexibility that a defined maturity strategy can bring to a fixed-income portfolio.

What are Guggenheim BulletShares® ETFs?

Guggenheim BulletShares ETFs are a suite of fixed-term exchange traded funds (ETFs) that provide defined maturity exposure through portfolios of either investment grade or high yield corporate bonds, enabling investors to build customized portfolios tailored to specific maturity profiles, risk preferences, and investment goals.

A defined maturity ETF’s portfolio is primarily comprised of securities that mature throughout the fund’s stated maturity year. Unlike traditional ETFs, which have a perpetual life, defined-maturity ETFs have a specified maturity date established when the ETF is launched. When the fund reaches its maturity date, its final net asset value (NAV) is returned to the current shareholders.

Introduced in 2010, BulletShares combine the benefits of bonds— monthly income, final distribution at maturity, as well as control of portfolio maturity, yield, and credit quality—with the advantages of ETFs—broad diversification, liquidity, transparency, convenience, and cost-effectiveness.

How are BulletShares ETFs different from individual bonds and traditional bond ETFs/funds?

BulletShares combine the best attributes of individual bonds and traditional bond ETFs/funds into one convenient package. Like bonds, BulletShares offer a defined maturity, real-time pricing and intra-day trading, however they also offer the convenience of traditional fixed-income funds, such as an attractive level of liquidity, price transparency and trading flexibility. Through BulletShares, investors can select the maturity and duration risk profile that best meets their needs. This is in contrast to traditional fixed-income funds, which offer a “one size fits all” approach.

Why are there challenges in using individual bonds?

Bonds trade over-the-counter. Navigating these markets in order to fill required specifications can be costly and time-consuming. Bonds are also subject to default risk and, in certain instances, available research on issues may be limited.

Historically, bonds do not trade as actively as equities, which can lower the level of liquidity and may cause price discrepancies. Bonds are also subject to availability. The implementation of Dodd-Frank, the Volcker Rule and other market reforms have shrunk bond inventories, while increasing the costs associated with acquiring such bonds.

What are the benefits of using BulletShares?

Guggenheim BulletShares allow investors to select the maturity and duration risk profile that best meets their needs. This is unlike traditional fixed-income funds, in which the maturity and duration risk profile is determined by the fund’s investment objective—which is typically a perpetual objective, such as five-year exposure. This perpetual objective doesn’t provide the precision of a specific maturity date and may hamper the ability to adapt to changing market conditions or investor needs. In addition, the exchange-traded structure offers access to real time pricing and intraday trading, as well as an efficient means to implement changes to a portfolio.

The required initial investment for an individual bond can be $10,000 or greater, varying widely by the type of bond. By investing through an ETF, investors now have access to comprehensive portfolios of bonds that may have previously been unavailable to them.

Explain the BulletShares maturity process.

As a BulletShares ETF nears its termination and bonds in the portfolio mature, the proceeds are generally reinvested in cash or cash equivalent securities earning prevailing short-term rates until the ETF terminates and the proceeds are distributed to shareholders. At the same time, the durations of the bonds still held in the portfolio are shortening. Both of these features help to minimize volatility and reduce interest rate risk. Additionally, holding the bonds to maturity, or until they are called, helps to capture a bond-like experience and can potentially insulate against interest rate fluctuations. Finally, at the end of the calendar year, the Defined Maturity ETF terminates and the fund assets, less any fees and expenses of the fund, are distributed to the shareholders1.

To date, the BulletShares suite has successfully matured nine issues.

How can BulletShares be used in a portfolio?

BulletShares offer a compelling combination of diversification and targeted bond investing—a potential substitute for individual bonds, enabling investors to implement strategies that may not otherwise be available to them. By providing targeted yield curve exposure, BulletShares allow investors to construct a maturity profile that may optimize their portfolios and generate income to help to manage cash flow needs.

BulletShares offer a cost-effective and diversified approach to bond laddering and generally lower costs than building a laddered portfolio with individual bonds. BulletShares ETFs may also efficiently fill portfolio gaps caused by matured or called bonds.

Why are BulletShares appealing right now?

BulletShares can be a potential solution for investors seeking to position for the potential of a rising interest rate environment. BulletShares typically maintain a duration profile similar to that of an individual bond and typically have a duration that declines as the fund approaches maturity, reducing sensitivity to interest rate changes.

The convenience of laddering with BulletShares may also be utilized to manage interest rate risk.  In a ladder strategy, as shorter-dated bonds mature, proceeds are rolled over and invested in bonds with longer-dated maturities. Offering broad exposure to the yield curve, the strategy gives fixed-income investors the opportunity to address movements in interest rates, while also maintaining the ability to customize cash flows to address individual needs. Data on annual returns dating back to 1900 indicates that simple bond ladders focused on maturities of 10 years or less delivered positive performance, according to Crestmont Research*.

Bond Ladders: Long-Term History

1900-2015

5-Year

7-Year

10-Year

Average Return

4.5%

4.6%

4.8%

Minimum Return

0.4%

0.3%

0.2%

Maximum Return

15.5%

15.7%

16.2%

*Crestmont Research.Copyright 2004–2015, Crestmont Research (www.CrestmontResearch.com). Chart is for illustrative purposes only and does not reflect future performance of any particular fund. Analysis reflects total return, taking into account “then-current” interest rates, as well as income received as interest payments each year. For the purposes of this analysis, maturing bonds and all interest are assumed reinvested in the respective ladders illustrated above. Composition of the five-year, seven-year, and 10-year ladder scenarios illustrated represents Treasuries and Treasury-equivalent investments.

How would an investor approach building bond ladders with BulletShares?

The BulletShares® ETF Bond Laddering Tool complements the BulletShares suite with an effective way to illustrate and implement ladder strategies. The tool functions to efficiently create strategies or may be utilized to fill portfolio gaps caused by matured or called bonds in existing strategies. The tool offers flexibility in modifying various inputs—such as start and end dates, credit quality, maturities and weighting of each ETF—the summary output illustrates the composition of the respective ladder. Building a ladder can be a challenge – both in terms of time and money.  The BulletShares ETF Bond Laddering Tool shows how the strategy can be incorporated effectively– saving both time and money.

¹ The Funds have designated years of maturity ranging from 2016 to 2025 and will terminate on or about December 31st of their respective maturity year. In connection with such termination, each Fund will make a cash distribution to then-current shareholders of its net assets after making appropriate provisions for any liabilities of the Fund. The Funds do not seek to return any predetermined amount at maturity. In the final six months of operation, as the bonds held by the Fund mature, the Fund's portfolio will transition to cash and cash equivalents, including without limitation U.S. Treasury Bills and investment-grade commercial paper, which may result in a lower yield than the yields of the bonds previously held by the Fund and/or prevailing yields for bonds in the market. The Funds will terminate on or about the date above without requiring approval by the Trust's Board of Trustees (the "Board") or Fund shareholders. The Board may change the termination date to an earlier or later date if a majority of the Board determines the change to be in the best interest of the Funds

Diversification neither assures a profit nor eliminates the risk of experiencing investment losses.

William H. Belden, III is a managing director at Guggenheim Investments. In his role, Mr. Belden directs business development for the firm’s line-up of ETFs, including distribution and marketing activities.

Prior to Guggenheim Investments, Mr. Belden worked as a senior product manager at Northern Trust Global Investments, where he was responsible for overseeing proprietary mutual fund products. Prior to Northern Trust, he was vice president of product management at Stein, Roe & Farnham and served as vice president for relationship management in the cash products group at Kemper Financial Services. Mr. Belden is regularly quoted in financial media outlets. He earned his MBA from the University of Chicago’s Booth School of Business and has a B.S. in finance from Miami University. He is series 7, 24 and 63 registered.

RISK CONSIDERATIONS
Investors should consider the following risk factors and special considerations associated with investing in the Funds, which may cause you to lose money, including the entire principal amount that you invest. Interest Rate Risk: As interest rates rise, the value of fixed-income securities held by the Funds are likely to decrease. Securities with longer durations tend to be more sensitive to interest rate changes, making them more volatile than securities with shorter durations. Credit/Default Risk: The risk that issuers or guarantors of debt instruments or the counterparty to a derivatives contract (BulletShares Corporate Bond ETFs only), repurchase agreement or loan of portfolio securities is unable or unwilling to make timely interest and/or principal payments or otherwise honor its obligations. Debt instruments are subject to varying degrees of credit risk, which may be reflected in credit ratings. Securities issued by the U.S. government have limited credit risk. Credit rating downgrades and defaults (failure to make interest or principal payment) may potentially reduce the Funds’ income and share prices. Asset Class Risk: The bonds in the Funds’ portfolio may underperform the returns of other bonds or indexes that track other industries, markets, asset classes or sectors. Call Risk/Prepayment Risk: During periods of falling interest rates, an issuer of a callable bond may exercise its right to pay principal on an obligation earlier than expected. This may result in the Funds having to reinvest proceeds at lower interest rates, resulting in a decline in the Funds’ income. Extension Risk: The risk that an issuer will exercise its right to pay principal on an obligation later than expected. This may happen when there is a rise in interest rates. Under these circumstances, the value of the obligation will decrease and the Funds’ performance may suffer from its inability to invest in higher yielding securities. Income Risk: The risk that falling interest rates will cause the Funds’ income to decline. Liquidity Risk: If the Funds invest in illiquid securities or securities that become illiquid, Fund returns may be reduced because the Funds may be unable to sell the illiquid securities at an advantageous time or price. Declining Yield Risk: During the final year of the Funds’ operations, as the bonds held by the Funds mature and the Funds’ portfolio transitions to cash and cash equivalents, the Funds’ yield will generally tend to move toward the yield of cash and cash equivalents and thus may be lower than the yields of the bonds previously held by the Funds and/or prevailing yields for bonds in the market. Fluctuation of Yield and Liquidation Amount Risk: The Funds, unlike a direct investment in a bond that has a level coupon payment and a fixed payment at maturity, will make distributions of income that vary over time. Unlike a direct investment in bonds, the breakdown of returns between Fund distributions and liquidation proceeds are not predictable at the time of your investment. For example, at times during the Funds’ existence, it may make distributions at a greater (or lesser) rate than the coupon payments received on the Funds’ portfolio, which will result in the Funds returning a lesser (or greater) amount on liquidation than would otherwise be the case. The rate of Fund distribution payments may adversely affect the tax characterization of your returns from an investment in the Funds relative to a direct investment in corporate bonds. If the amount you receive as liquidation proceeds upon the Funds’ termination is higher or lower than your cost basis, you may experience a gain or loss for tax purposes. In addition the Funds are subject to Non-Correlation Risk, Replication Management Risk, Issuer-Specific Changes, and Non-Diversified Fund Risk. The investment-grade corporate bond ETFs also entail the following risks. Foreign Issuers Risk: Investing in U.S. registered, dollar-denominated bonds of foreign corporations which have different risks than investing in U.S. companies. These include currency, political, and economic risk, as well as less market liquidity, generally greater market volatility and less complete financial information than for U.S. issuers. Derivatives Risk: The Funds may invest in certain types of derivatives contracts, including futures, options and swaps which, increases the risk of loss for the Funds. The high-yield corporate bond ETFs also entail the following risks: High-Yield Securities Risk: The Funds invest in bonds that are rated below investment-grade and are considered to be “junk” securities. While these securities generally offer a higher current yield than that available from higher grade issues, they typically involve greater risk. The ability of issuers of high-yield securities to make timely payments of interest and principal may be adversely impacted by adverse changes in general economic conditions, changes in the financial condition of the issuers and price fluctuations in response to changes in interest rates. High-yield securities are less liquid than investment-grade securities and may be difficult to price or sell, particularly in times of negative sentiment toward high-yield securities. Concentration Risk: If the Index concentrates in an industry or group of industries the Fund’s investments will be concentrated accordingly. In such event, the value of the Fund’s shares may rise and fall more than the value of shares of a fund that invests in securities of companies in a broader range of industries. In addition, the high-yield corporate bond ETFs may entail some or all of the following sector risks. Financial Services Sector Risk, Consumer Staples Sector Risk, Telecommunications Sector Risk, and Consumer Discretionary Sector Risk. Please read each Fund’s prospectus for more detailed information on these risks and considerations. As with any investment, you should consider how your investment will be taxed. The tax information contained in the prospectus is provided as general information.

This article herein is for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product.  This information is subject to change at any time, based on market and other conditions.

Read a prospectus and summary prospectus (if available) carefully before investing. It contains the investment objectives, risks, charges, expenses and other information, which should be considered carefully before investing. To obtain a prospectus and summary prospectus (if available) visit GuggenheimInvestments.com

The referenced funds are distributed by Guggenheim Funds Distributors, LLC. Guggenheim Investments represents the investment management business of Guggenheim Partners, LLC (“Guggenheim”), which includes Guggenheim Funds Investment Advisors (“GFIA”), the investment advisors to the referenced funds. Guggenheim Funds Distributors, LLC is affiliated with Guggenheim and GFIA.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.



This article appears in: Investing , ETFs , Investing Ideas



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