FYI: Buying individual bonds to ladder for clients’ needs comes with its own issues, such as varying returns and having to keep them in a separately managed account. Even on the ETF side, most bond ETFs keep constant maturities that open investors to duration risk.
Enter target-maturity bond ETFs. These funds hold fixed-income investments with similar maturities, varying by year. The instruments are held to maturity, and when that happens, the fund closes and all cash is returned to investors.
Regards,
Ted
http://www.etf.com/publications/etfr/can-target-maturity-bond-etfs-replace-individual-bonds?nopaging=1
Comments
Vanguard has a much more analytic piece on DMFs here:
https://personal.vanguard.com/pdf/ICRDMB.pdf
Call it confirmation bias, but I think it's spot on. They observe that the protection against rising rates that individual bonds (or DMFs) supposedly offer is essentially illusory. That's because as rates rise, bond prices drop. You may choose to think "well, I'm not selling, so I haven't lost value", but you've paid an opportunity cost (not getting the higher yield of new bonds) equal to the price drop. Vanguard says that the "return of principal ... benefit is more emotional in nature."
They note that even laddering bonds (or DMFs) has increased volatility relative to a "regular" fund (or ETF) because of the saw-tooth nature of laddered bond duration. It falls until a bond matures, then spikes up with the replacement bond, and then repeats this pattern.
Where DMFs excel IMHO is in immunizing a bond portfolio. If you've got a particular need some time down the road (e.g. college expenses), you can invest in a DMF that matures just when you need that money. ISTM that here zero coupons work best, because then there's no reinvestment risk (the possibility that you won't get the same rate of return on reinvested interest). Only American Century offers zero DMFs, and it isn't issuing any new ones.
Vanguard also identifies what it considers a drawback of ETF DMFs vs. OE DMFs: "Investors purchase DMF exchange-traded funds (ETFs) at market price, but receive net asset value (NAV) at maturity. The difference in these amounts represents a sometimes unrecognized cost that investors may incur."
Aside from that, the higher costs of OEFs, and the usual ETF overhead of brokerage fees, market spread, etc., OEF and ETF DMFs seem to have pretty much the same benefits and drawbacks.