It looks like a bond and smells like a bond, but it's an ETF

iShares planning series of target-date exchange-traded funds that hold baskets of investment-grade bonds

Oct 25, 2012 @ 10:31 am

By Jason Kephart

BlackRock Inc.'s exchange-traded fund arm, iShares, plans to launch a series of corporate bond ETFs that look and act like individual bonds.

The proposed series of iShares Corporate Bond Funds will be a set of target-date ETFs, each holding a basket of investment-grade bonds set to expire in their given year. The San Francisco-based ETF provider already offers a similar suite of products that hold municipal bonds.

Fixed-income ETFs have been in high demand for the past two years as investors look for more targeted and liquid access to bond markets. Bond ETFs had $39 billion of inflows through the end of September, the most of any asset class, according to Morningstar Inc. That puts them on pace to beat last year's record inflows of $43 billion, which were more than double those in 2010.

Even with the sudden popularity, bond ETFs have a long way to go to catch up with their equity siblings, which hold more than $900 billion.

Mark Wiedman, 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.

Mr. Wiedman explained that some traditional fixed-income investors aren't fully on board with bond ETFs because they don't know enough about them yet. Others are put off by the fact that the funds come with a ticker symbol and trade intraday, making them resemble a stock rather than a bond.

“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.”

The idea behind the target-date ETFs is to give investors who typically buy individual bonds the same set of maturity and expected yields they're used to, but with the benefit of getting a diversified basket of bonds in a single purchase with a lower minimum investment and cheaper bid/ask spreads.

In 2010, Guggenheim Investments became the first ETF firm to offer target-date bond ETFs with the launch of its BulletShares lineup of corporate and high-yield bonds.

BulletShares ETFs recently hit $1.75 billion in assets, and the firm's research shows that investors are in fact treating them like individual bonds. Bill Belden, head of product development at Guggenheim, said there has been only one redemption since the suite was introduced.

Not surprisingly, Guggenheim is seeing the most interest in its target-date bond ETFs maturing in 2013, 2014 and 2015, which is when the Federal Reserve has said it's likely to begin raising rates again. By having bonds that come due around that time, advisers can reinvest at the higher interest rates.

Rising interest rates generally spell doom for traditional bond mutual funds. A 1% rise in rates would cause a 4% to 5% loss in the Barclays Aggregate Bond Index, for example.

The Guggenheim BulletShares Corporate Bond ETFs charge 42 basis points. The iShares products are expected to be priced competitively.

An initial filing with the Securities and Exchange Commission did not list the expense ratios or specific target-dates that iShares plans to offer. Spokeswoman Christine Hudacko declined to comment while the ETFs are in registration.

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