This strategy can maximize yield even as interest rates fall
With Federal Reserve rate cuts now underway, investors may want to make sure they have the right bond strategy. One way to get a predictable source of income — and some comfort in knowing you’ll get your investment back at maturity — is to build a bond ladder. A ladder is essentially owning a series of issues that have staggered maturities. When a bond matures, the money can be reinvested again at the end of the ladder. The strategy is meant to minimize interest rate risks, explained Saraja Samant, a manager research analyst at Morningstar. “When interest rates are going lower, even if the nearest rung matures and you’re going to reinvest that at a lower rate, you have the maturity portion of your portfolio still locked in at now higher rates,” she said. The strategy typically uses bonds or defined maturity exchange-traded funds , like Invesco’s BulletShares and BlackRock’s iBonds . Defined maturity ETFs provide diversity like traditional funds but have maturities and liquidate like a bond. Global X recently launched three ETFs that have a Treasury ladder within the fund. Its short-term Treasury ladder ETF focuses on securities maturing between one to three years, its intermediate-term fund aims for exposure on securities maturing between three and 10 years and its long-term ETF targets those maturing in 10 to 30 years. The funds each have total expense ratios of 0.12%. Global X believes this is the right time for these types of funds. “By entering into a Treasury Ladder amidst a rate cutting cycle, investors gain exposure to falling rate tailwinds, while the equal-weighted ladder design allows investors to adopt a thoughtful stance on duration management in the face of potential interest rate volatility,” said Robert Scrudato, director of options and income research at Global X . There aren’t many ETFs that hold ladders currently on the market. Wisdom Tree has two Treasury ladder ETFs: a one- to three-year fund and a seven- to 10-year fund. Schwab has Treasury bond ladder strategies in separately managed accounts operated by its Wasmer Schroeder Strategies’ team. BlackRock also appears to be looking to enter the space. The asset manager submitted filings to the Securities and Exchange Commission in August for new iShares ETFs that hold ladders in corporate bonds, high-yield securities and Treasurys. An ETF that holds a bond ladder could be a good move for someone looking to start a position or who has a smaller portfolio, said certified financial planner Barry Glassman, founder and president of Glassman Wealth Services in Vienna, Virginia. “They get instant diversification into anywhere from a half dozen to a dozen bond maturities at once,” he said. “They can add to or take from the entire bond ladder all at once, which is challenging to do with an individual bond ladder.” ETFs, however, are affected by investor cash flows in and out of the funds, Morningstar’s Samant pointed out. The ‘comfort’ of a ladder To build a Treasury ladder, investors can go to Treasury Direct or use a broker dealer and tailor it to their needs, Samant said. Those buying corporate bonds may be better off building a ladder of defined maturity ETFs, since there is a lot of research and markups involved in buying individual corporate bonds, she added. Ladders are also transparent and give investors some comfort, said Michael Kessler, senior portfolio manager at Albion Financial Group in Salt Lake City. “What we find is directly owning individual bonds in a ladder form, where they have a specific maturity date, that can help our clients achieve a greater level of comfort that they are going to get their principal back in the end,” he said. It also helps investors think longer term than they typically would, Glassman said. “It’s psychology giving the permission to go out further than an investor would normally feel comfortable, especially with an inverted yield curve where short term is paying more than long term,” he said. That said, not every corner of the bond market necessarily should be laddered, Kessler noted. His firm uses them for their short- to medium-term investment-grade corporate bond exposure. However, he’s also added more exposure to mortgage-backed securities and securitized products, like AAA collateralized loan obligations, in his portfolios. For those assets, he uses ETFs, which give access to the market in a diversified, low cost way, he said.
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