iBonds: a major breakthrough in bond ETFs?

• Level: For advanced
• Reading duration: 5 minutes

iBonds ETFs: What are they?

iBonds ETFs are exchange-traded funds that invest in an underlying portfolio of individual bonds. So far, so normal. But what sets iBonds ETFs apart from traditional bond funds is that each one matures in a specific year. For example, if you choose the iBond ETF that matures in 2026 then, when it reaches its target date, the fund will close and you will receive your invested capital back plus your accumulated interest payments. In contrast to traditional bond funds, iBonds are designed to deliver a more predictable yield than with the standard approach. That’s because traditional bond ETFs must constantly trade their underlying bonds in order to stay within a certain maturity range. For example, a 7-10 year maturity bond ETF never holds its bonds to term because its remit is to stay in the intermediate range of seven to ten years until redemption. Thus it offloads bonds as they reach the seven year mark and buys in longer dated ones that fit the ETF’s position on the yield curve. This requirement to sell exposes traditional bond funds to interest rate risk. That is, the chance they book a loss when selling bonds whose value has declined after interest rates have risen. iBonds evade much of this interest rate risk because the fund is linked to a maturity date not a maturity range. Thus its portfolio may be left alone to mature at face value, as opposed to being cashed in early at a loss (if rates are up) or gain (if rates are down). The upshot is that target maturity bond ETFs are useful if you prize receiving a relatively stable yield-to-maturity above all else. Without iBonds, this type of bond laddering or duration-matching is often done with portfolios of individual bonds. However, iBonds enable investors to achieve the same effect without having to pay large spreads or dealing costs on the bond markets, nor deal with large minimum investment limits. They also enable you to efficiently diversify your portfolio across a broad range of securities if you choose the corporate bond option. That said, iBonds ETFs can only do their job if you hold them until their maturity date. Otherwise, you’re taking the same interest rate risk as any other bond fund type. Though that can work in your favour if rates have fallen since your purchase.

How do traditional bond ETFs differ from iBonds?

The table below highlights the differences between iBonds ETFs and traditional bond ETF investing.

Key differences between iBonds and other bond investments

As you can see from our table, iBonds ETFs combine some of the advantages of standard bonds with those of ETFs. Remember the target maturity element means an iBonds ETF has a finite lifespan - like a fixed rate savings account. When the maturity date is reached, your principal is returned, along with your achieved yield less the fund’s expenses.

What products are available?

UCITS-compliant iBonds ETFs from iShares are available in seven different variations on the European market. These products invest in US corporate bonds and Treasuries, and the target maturities range from 2025 to 2028.

Should I invest in iBonds?

Accumulators and anyone not interested in managing the reinvestment of their fixed-income portfolio may find that traditional bond ETFs are better suited to their needs. With these products, the ETF manager automatically handles the reallocation of the securities within the ETF. Moreover, you can remain invested so long as the ETF suits your needs. For more advanced ETF enthusiasts and those who want to match a predictable income stream against their future liabilities, the new iBonds ETFs are certainly worth considering. They allow you to build a bond ladder by purchasing ETFs with target maturities that land in the years when you wish to pay off known expenses.

Our iBonds verdict

For us, the iBonds concept from iShares doesn’t render all other bond ETFs obsolete. But it is undoubtedly an excellent innovation and a very useful addition to the existing range of bond ETFs. The target audience for iBonds ETFs is likely to be primarily institutional investors or advanced individuals who have allocated significant sums to the fixed-income portion of their portfolios. Hopefully the pointers above can help you decide whether iBonds belong in your portfolio.

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