ETF Bond Investing and Avoiding Rate Risk: Target Maturity Bond ETFs

So here’s your predicament: you think the markets are overvalued and you still want yield, but yields are still at near all-time lows and long term bonds suffer from extreme rate risk (where rising yields will eat away at bond prices).   And you can’t invest in Canadian Real Estate because it is in one of the largest bubbles in history.  And, finally, you do not want to pick and choose bonds yourself i.e. you want a bond fund.

If you just invest in a short-term, medium-term, or long-term bond ETF, (for example:  BMO Short Bond ETF Ticker: ZCS) you are still exposed to uncertainty regarding rate risk.  The problem is that these funds are perpetually recycling your capital into new short term bonds.  Unlike purchasing a bond directly, they do not have a specific maturity.  So, how do you invest in bonds within an ETF that DO have a specific maturity.

Enter: Target Maturity Bond ETFs

These are “diversified” bond funds that contain many bond offerings that all mature at or around a specific date.  Once all of the bonds within the fund mature, the principal is returned to investors and the ETF is dissolved.  So, it functions like a portfolio of managed bonds with a small management fee.   Most of them make monthly distributions, so they are an interesting investment for those who prefer to invest in ETF bond funds, but fear the risk of rising rates. As far as we know, only RBC offers these in Canada, but in the US, Guggenheim and a few others offer similar products.

A couple of things to keep in mind.  These ETFs will likely be trading at a premium to their eventual final distribution of the principal.  You’re looking at Par Value per Unit to determine what this is and yield to maturity will tell you what the actual annual yield will be until the ETF is dissolved.

Here’s an example of a short term Target Maturity Bond ETF in Canada. The RBC Target 2020 Corp Bond ETF  (TSX: RQH).  They also have offerings for 2019, 2021, 2022, etc… depending on your timeframe for investment.  I specifically mentioned 2020 because, full disclosure, I am invested in it at the moment.  I’m planning on making a very large purchase at the end of 2020 and I’ve earmarked the cash for it by investing in this fund.   So, if you look at this particular ETF, you will see that the current yield is 2.89%, but the yield to maturity is 2.39% (this is really the actual yield you will receive all-told).  This is because the market price of the ETF is $20.00 and the par value per unit is $19.63, meaning $0.37 of the $20 will not be returned in the final distribution.

If you look at the holdings of this ETF, you will notice they are mostly bank stocks and other financials, but that’s life in bond investing and chasing yield in 2018.  Banks are the ones who need all the capital so they can make bad loans that are insured by the federal government.  But we’re getting off topic.

If you’re looking to invest in these funds, keep in mind they are generally individually fairly small and with low volume, so be mindful of that if you’re thinking of placing a market order.

Here is the complete list of RBC’s Target Maturity ETFs

RQE – RBC Target 2017 Corporate Bond Index ETF
RQF – RBC Target 2018 Corporate Bond Index ETF
RQG – RBC Target 2019 Corporate Bond Index ETF
RQH – RBC Target 2020 Corporate Bond Index ETF
RQI  – RBC Target 2021 Corporate Bond Index ETF
RQJ – RBC Target 2022 Corporate Bond Index ETF
RQK – RBC Target 2023 Corporate Bond Index ETF

Here is a complete list of Target Maturity Bond ETFS traded in the USA (denominated in USD)