Conventional fixed-income ETFs are not the reduced-risk investment many expect. Actually, they are aggressive active bets on the direction of future interest rates. That gamble worked magnificently for most of the past 33 years. But unless we expect substantial negative interest rates (i.e. huge taxes against savings), that play has to sour going forward. To achieve what we really want from fixed income, we need maturity dates, something we get from Guggenheim’s “defined maturity” ETFs.

The Problem

To manage interest-rate risk, bondholders adjust maturity (specifically, “duration,” a more sophisticated measure that blends the maturity date, the magnitude of the coupon and interest on interest, but we can get a sense of what’s going on if we just think in terms of maturity). If you expect rates to fall, you want the longest maturities or durations you can get, which is why never-maturing fixed-income ETFs have made so many investors so happy – so far. But when rates rise, we prefer shorter maturities or durations (so we can more quickly get our money back to reinvest at higher yields). When rates rise, fixed-income securities that never mature are the worst things you can have. (See this 9/30/15 post for more details).

Traditional fixed-income ETFs like iShares iBoxx Investment Grade Corporate Bond ETF ($LQD), a robo-adviser favorite, publish statistics for duration and maturity. But those numbers are meaningless; they’re nothing more than marketing bullet points. Such computations require defined maturity dates, which don’t apply to $LQD (they apply to individual bonds owned by $LQD, but those are never cashed in and the values are never paid to shareholders; instead, this permanent portfolio sells them as they age and replaces them with other, younger, bonds). So you don’t really have a stake in fixed-income. Instead, what you have is something like a British Consol, a class of permanent fixed-income securities redeemable only at the option of the government (which fortunately for investors facing rising rates, have by now been fully redeemed).

A Solution – Guggenheim BulletShares

Guggenheim, recognizing that fixed-income can’t be for real without genuine maturity dates, designed a series of funds (branded BulletShares) designed “to combine the best aspects of owning an individual bond and the best aspects of owning a bond fund” according to Bill Belden, Guggenheim’s Managing Director for ETF Development.

For an example of how this works, consider the Guggenheim BulletShares 2020 Corporate Bond ETF ($BSCK), five years from now. As 2020 approaches, the typical fixed income fund will sell bonds and buy new ones in such a way that it keeps its target five-year maturity. Guggenheim doesn’t do that. It continues to hold and as individual bonds mature, the ETF will get the cash from the issuers and accumulate the proceeds in a cash or near-cash account; at the end of the year 2020, when all the bonds are gone, the cash will be paid to $BSCK shareholders. The fund will then vaporize into the ethers (in legal terms, liquidate).

This is not a risk-free investment. Like $LQD, $BSCK assumes credit risk, but from the strongest (“investment grade”) corporate borrowers. Also, as Belden points out, there is secondary-market interest-rate risk. $BSCK and its BulletShares peers will rise and fall with the ebb and flow of interest rates. Payment at 100 cents to the dollar (assuming no credit defaults) requires holding to maturity, as would be the case with any bond. The difference is that however badly interest rates may move against bondholders, $BSCK shareholders know they’ll be able to cash out and be whole at the end of 2020. Shareholders of $LQD can only cash out by selling in the secondary market and accepting their losses.