Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.
I'm curious about the workings, pros and cons, of an ETF such as ISHARES IBONDS TERM TREASURY ETF IV IBTH.
Since I'm starting from a position of total ignorance, it's highly likely that you folks know a lot more about this sort of thing than I do. On the plus side, total ignorance at least guards against false beliefs.
The usual reasons to buy a bond fund instead of an individual bond are: issuer diversification, individual security credit risk, maturity/duration diversification, and liquidity. With Treasury funds, you don't get issuer diversification (only one issuer - the Treasury), and no concern with credit risk. Since all bonds mature in the same year, there's little interest risk diversification the fund gives you aside from minor duration differences between the bonds.
It would be different if you were thinking about corporate bullet funds, e.g. BSCR or IBDS. With these you get real issuer diversification and credit risk diversification.
Some people prefer funds because they're more familiar and/or easier to trade. That seems to be the main selling point of bullet treasury funds. That said, Treasuries are very liquid. You can think of buying IBTH as the same as buying 20 Treasuries, all with roughly the same maturity date, and thus roughly the same YTM.
If you buy a term ETF now and hold it to maturity, you should receive roughly the SEC yield. That is currently 4.03% for IBTH. You can likely do a couple of basis points better by buying individual Treasuries and holding to maturity. And there's no particular reason to buy more than one CUSIP (i.e. multiple identical treasury bonds).
Fidelity shows 3 year (maturing early 2027) Treasuries yielding 4.17% and 3 year zeros yielding 4.18%. Subtract a few basis points for the $1/bond trading fee; subtract another few basis points for getting a small number of bonds. OTOH, IBTH seems to always trade at a slight premium to NAV, which hurts its expected yield. And there's the 7 basis point ER it charges.
There doesn't seem to be anything wrong with funds like these. If you prefer funds to individual bonds (given roughly equal risk and returns) and you want to cash out in a particular year (e.g. for that trip around the world you've always planned), these seem fine.
I have to say that if (at this time) over 140 of you have looked at this post and only one of you has been able to help, then I don't feel nearly as stupid as I did when I asked for help on this.
Hey @Old_Joe - I’ve been interested in laddering their cousins, the ishares ibonds (IBDQ - 2yr and IBDR - 3yr) term maturity bond etfs, and as a full disclaimer, I’m a novice when it comes to these etfs and individual bills, notes, and bonds. The etfs I’ve been curious about are corporates. I find buying individual treasuries (3, 6, 12 months) at Vanguard effortless without a markup fee or ER.
The defined-maturity etfs quote their yield, just as individual bonds; so knowing the predicted income in advance, is intriguing, until I understood from other investor experiences, that they cannot guarantee the exact yield publicized, at maturity. Not all investors will hold to maturity; not all notes and bonds mature at the same time within that year; and then there are the potential defaults (corporates of course). The portfolio would need to continue buying additional corporate notes/bonds, perhaps at lower rates.
“Cost” and “Control” have become more important to me (and perhaps you) given our 2021-22 bond fund experience. This is why I’ve been laddering t-bills at auction. I know what I’m getting at maturity. Even if the total return “might” be greater in a bond fund when short term rates are cut by the Fed. I’m not interested in a cracker jacks box surprise toy (we folks of a certain age will remember). Still, I’m invested in VWIAX so the longer bonds should help when rates come down.
So all in all, I’m more interested in these DM etfs than bond funds, and still tempted. Mean while I’ve taken an interest in individual Agency bonds and will also look to slowly invest in longer individual treasuries.
@Old_Joe — Oftentimes it pays to acknowledge your ignorance. When I first started buying CDs last winter, I was ignorant of some important details— such as whether they are callable. Some more knowledgeable posters pointed that out to me, and I restricted all of my later purchases to noncallable CDs.
I wish I had sought input, like you, when I bought Fidelity’s TIPs index fund several years ago. I thought it would protect a portion of my portfolio from inflation spikes. It did just the opposite. It was my worst performing bond fund when the Fed started raising interest rates. Ended up selling it for a big loss.
Not all investors will hold to maturity; not all notes and bonds mature at the same time within that year; and then there are the potential defaults (corporates of course). The portfolio would need to continue buying additional corporate notes/bonds, perhaps at lower rates.
Consider just two investors and a single CUSIP. Investor 1 buys in now, investor 2 in a year.
We'll start off as simple as possible. Let's say the current market rate on a 3 year Treasury is 4%, and the underlying Treasury bonds, maturing in 3 years have 4% coupons. So they trade at par. Let's also say that the ETF shares are $100/share.
Investor 1 comes in an invests $10,000. That's 100 shares, buying 10 bonds at par in the underlying portfolio.
A year goes by. We'll assume that the yield at that moment on 2 year treasuries is 3.5%. Shorter term bonds typically have lower yields, or perhaps all rates dropped over that year. The reason doesn't really matter.
A two year bond with a 4% coupon and a YTM of 3.5% is priced at 100.9577. You can find that with a calculator, e.g. Fidelity's, and you can verify it with EXCEL: EXCEL function: YIELD(DATE(2024,1,1), DATE(2026,1,1), 4%, 100.9577, 100, 2)
Because the underlying bonds have appreciated from 100 to 100.9577, the share price has likewise appreciated from $100 to $100.9577.
Investor 2 comes in and buys 100 shares for $10,095.77. Keep in mind that the YTM at the time is 3.5%. Now each investor owns 100 shares.
At maturity, Investor 1 has received three years worth of coupons at a rate of 4% and gets back the original $10,000 investment when the bonds mature and the fund is liquidated. That's your basic 4% yield. The fact that Investor 2 bought additional shares at a higher price (lower yield) had no effect.
At maturity, Investor 2 has received two years worth of coupons at a rate of 4%, but gets back $95.77 less than the original investment. That's because the investor bought the bonds at a premium.
The YTM that Investor 2 received was 3.5% - just what the market rate on two year bonds was when the investment was made. See the EXCEL expression above. In short, having to buy or sell bonds shouldn't affect the fund's behavior. That's unlike "normal" Treasury bond funds where trading can alter the portfolio's average maturity. (In corporate bond funds, trading can also affect credit quality and risk.)
The fact that the bonds mature over a period of a year can somewhat reduce yield. In that last year, as bonds mature their proceeds are held as cash (think 3 mo Treasuries) which should yield somewhat less than 12 mo Treasuries. Or as the prospectus puts it:
Declining Yield Risk. During the six months prior to the Fund’s planned termination date, the Fund’s yield will generally tend to move toward prevailing money market rates and may be lower than the yields of the bonds previously held by the Fund and lower than prevailing yields for bonds in the market.
... when I bought Fidelity’s TIPs index fund several years ago. I thought it would protect a portion of my portfolio from inflation spikes. It did just the opposite. It was my worst performing bond fund when the Fed started raising interest rates.
Even worse, speaking of deep dumminess, I knew well (he said) that STIP would not be particularly protective, and I also knew it would fare meh or worse than meh with rate raises ... but I did not anticipate how much it would punk out and take time to get back to breakeven. Still better than BND, BSV, VGIT, which turned out to be amazingly bad. No selling of any of these yet, though.
Comments
The usual reasons to buy a bond fund instead of an individual bond are: issuer diversification, individual security credit risk, maturity/duration diversification, and liquidity. With Treasury funds, you don't get issuer diversification (only one issuer - the Treasury), and no concern with credit risk. Since all bonds mature in the same year, there's little interest risk diversification the fund gives you aside from minor duration differences between the bonds.
It would be different if you were thinking about corporate bullet funds, e.g. BSCR or IBDS.
With these you get real issuer diversification and credit risk diversification.
Some people prefer funds because they're more familiar and/or easier to trade. That seems to be the main selling point of bullet treasury funds. That said, Treasuries are very liquid. You can think of buying IBTH as the same as buying 20 Treasuries, all with roughly the same maturity date, and thus roughly the same YTM.
If you buy a term ETF now and hold it to maturity, you should receive roughly the SEC yield. That is currently 4.03% for IBTH. You can likely do a couple of basis points better by buying individual Treasuries and holding to maturity. And there's no particular reason to buy more than one CUSIP (i.e. multiple identical treasury bonds).
Fidelity shows 3 year (maturing early 2027) Treasuries yielding 4.17% and 3 year zeros yielding 4.18%. Subtract a few basis points for the $1/bond trading fee; subtract another few basis points for getting a small number of bonds. OTOH, IBTH seems to always trade at a slight premium to NAV, which hurts its expected yield. And there's the 7 basis point ER it charges.
There doesn't seem to be anything wrong with funds like these. If you prefer funds to individual bonds (given roughly equal risk and returns) and you want to cash out in a particular year (e.g. for that trip around the world you've always planned), these seem fine.
OJ
The defined-maturity etfs quote their yield, just as individual bonds; so knowing the predicted income in advance, is intriguing, until I understood from other investor experiences, that they cannot guarantee the exact yield publicized, at maturity. Not all investors will hold to maturity; not all notes and bonds mature at the same time within that year; and then there are the potential defaults (corporates of course). The portfolio would need to continue buying additional corporate notes/bonds, perhaps at lower rates.
“Cost” and “Control” have become more important to me (and perhaps you) given our 2021-22 bond fund experience. This is why I’ve been laddering t-bills at auction. I know what I’m getting at maturity. Even if the total return “might” be greater in a bond fund when short term rates are cut by the Fed. I’m not interested in a cracker jacks box surprise toy (we folks of a certain age will remember). Still, I’m invested in VWIAX so the longer bonds should help when rates come down.
So all in all, I’m more interested in these DM etfs than bond funds, and still tempted. Mean while I’ve taken an interest in individual Agency bonds and will also look to slowly invest in longer individual treasuries.
I wish I had sought input, like you, when I bought Fidelity’s TIPs index fund several years ago. I thought it would protect a portion of my portfolio from inflation spikes. It did just the opposite. It was my worst performing bond fund when the Fed started raising interest rates. Ended up selling it for a big loss.
https://www.bogleheads.org/forum/viewtopic.php?t=374405
There had been a good deal of discussion there regarding defined maturity bond etfs.
Consider just two investors and a single CUSIP. Investor 1 buys in now, investor 2 in a year.
We'll start off as simple as possible. Let's say the current market rate on a 3 year Treasury is 4%, and the underlying Treasury bonds, maturing in 3 years have 4% coupons. So they trade at par. Let's also say that the ETF shares are $100/share.
Investor 1 comes in an invests $10,000. That's 100 shares, buying 10 bonds at par in the underlying portfolio.
A year goes by. We'll assume that the yield at that moment on 2 year treasuries is 3.5%. Shorter term bonds typically have lower yields, or perhaps all rates dropped over that year. The reason doesn't really matter.
A two year bond with a 4% coupon and a YTM of 3.5% is priced at 100.9577. You can find that with a calculator, e.g. Fidelity's, and you can verify it with EXCEL:
EXCEL function: YIELD(DATE(2024,1,1), DATE(2026,1,1), 4%, 100.9577, 100, 2)
Because the underlying bonds have appreciated from 100 to 100.9577, the share price has likewise appreciated from $100 to $100.9577.
Investor 2 comes in and buys 100 shares for $10,095.77. Keep in mind that the YTM at the time is 3.5%. Now each investor owns 100 shares.
At maturity, Investor 1 has received three years worth of coupons at a rate of 4% and gets back the original $10,000 investment when the bonds mature and the fund is liquidated. That's your basic 4% yield. The fact that Investor 2 bought additional shares at a higher price (lower yield) had no effect.
At maturity, Investor 2 has received two years worth of coupons at a rate of 4%, but gets back $95.77 less than the original investment. That's because the investor bought the bonds at a premium.
The YTM that Investor 2 received was 3.5% - just what the market rate on two year bonds was when the investment was made. See the EXCEL expression above. In short, having to buy or sell bonds shouldn't affect the fund's behavior. That's unlike "normal" Treasury bond funds where trading can alter the portfolio's average maturity. (In corporate bond funds, trading can also affect credit quality and risk.)
The fact that the bonds mature over a period of a year can somewhat reduce yield. In that last year, as bonds mature their proceeds are held as cash (think 3 mo Treasuries) which should yield somewhat less than 12 mo Treasuries. Or as the prospectus puts it: