Investing on your own in fixed income markets can be extremely challenging. Unlike the stock market where equities trade thousands of times throughout the day on a public exchange, the bond market is notoriously difficult to navigate because trades are not placed on an exchange, they are instead placed over the counter and even the most liquid bonds available may only change hands a few times per day. Even if an investor is able gain a grasp on the fair value of a particular bond, building out a diversified portfolio of bonds is an entirely different challenge given that the minimum investment for one particular bond could be $10,000 (or more). And even if you think you’ve found the perfect bonds for you it can be challenging and time consuming to find sellers willing to sell those bonds to you at your preferred price.
Investing in Fixed Income via Mutual Funds and ETFs
Investing in fixed income through a mutual fund or traditional ETF solves many of these problems. Rather than purchasing an individual bond, a mutual fund or ETF buyer is purchasing a basket of bonds. By making one purchase they gain exposure to hundreds or even thousands of bonds.
However, gaining fixed income exposure through a mutual fund or a traditional ETF can come with a couple of drawbacks: interest rate risk and uncertainty. If an investor buys a basket of bonds and interest rates increase, the investor will likely experience negative returns if the price decrease of the bonds caused by the interest rate change is not offset by the coupon income from the portfolio.
One of the advantages of buying an individual bond is that the buyer has a degree of certainty of what their return will be (assuming the bond does not default). A yield to maturity is the total return on a bond if the bond is held to its maturity date and assuming the issuer does not default and makes all interest and principal payments in full. The yield to maturity is known at the time of purchase, so if an investor purchases one bond at a yield to maturity of 3%, he knows what his return over the life of the bond will be assuming the bond does not default. Buying a basket of bonds through a mutual fund or ETF introduces some degree of unpredictability to the return and cash flow stream. Unlike an individual bond with a stated maturity, a bond mutual fund or traditional bond ETF will not have a stated maturity. Instead the composition of the basket of bonds is constantly changing as new bonds are added to the portfolio to replace bonds that are sold, called, or matured.
The overall yield on a mutual fund or ETF may be 3% but an investor may not actually realize that 3%. If interest rates go up, for example, the investor may earn much less than 3%. This can be unnerving for investors, especially if they are counting on their bond holdings to provide a steady and predictable return.
Building a Traditional Bond Ladder
A traditional bond ladder provides a solution to the issue of unpredictability. To build a bond ladder, an investor will create a portfolio of bonds with maturities at different intervals. For example, an investor can buy a bond that matures in one year, a bond that matures in two years, a bond that matures in three years, and so forth. When a bond matures, the proceeds can then be redeployed. The investor has created a predictable stream of income through their bond ladder.
The drawbacks to a traditional bond ladder are the complexities involved in purchasing an individual bond and the default risk of a portfolio with exposure to a small number of issuers. If an investor builds a 5-year bond ladder with five individual bonds and one (or more) of the bonds goes into default then the default will have a significant impact on the investor’s returns considering that each bond makes up 20% of the investor’s bond portfolio.
In comparison, a mutual fund or traditional ETF typically owns hundreds or even thousands of bonds. This means that a single bond going into default will have a far less devastating impact if that bond is one of a thousand bonds in your portfolio instead of one of 5 bonds in your portfolio.
Introducing the MILES Bond Portfolio
WrapManager’s Monthly Income Laddered ETF Strategy (MILES) Bond Portfolio is designed to be a combination of a bond ladder and a basket of bonds. The strategy is made up of ETFs that each hold hundreds of underlying bonds. Each ETF holds bonds that all mature in a particular year. So instead of buying one bond to fill one year on the bond ladder, an investor in a defined maturity ETF buys one ETF and gains exposure to hundreds of bonds for that particular year on bond ladder.
These defined maturity ETFs are the building blocks of the MILES Bond Portfolio constructed and managed by the WrapManager Investment Policy Committee. The MILES Bond Portfolio is designed to allow the investor to be able to have a laddered approach the seeks to minimize interest rate risk while also offering a large basket of bonds to minimize default risk. In other words, the MILES Bond Portfolios were created to have investment features similar to a traditional bond ladder while offering additional advantages inherent in an ETF including offering broad diversification to minimize risk.
Moreover, the ETFs in the MILES Bond Portfolio seek to pay a monthly dividend unlike a traditional bond which typically only pays interest twice a year.
Currently, WrapManager offers 3 distinct styles of the MILES Bond Portfolio.
- The MILES Bond Portfolio – Corporate offers exposure to investment grade corporate bonds through a laddered approach. Investment grade corporate bonds typically offer a more attractive yield than a US Treasury of the same maturity. Investment grade corporate bonds are typically considered to be less of a credit risk than high yield bonds.
- The MILES Bond Portfolio -- High Yield offers exposure to high yield bonds through a laddered approach. High yield bonds are typically considered to be a greater credit risk than investment grade corporate bonds. To compensate for the greater credit risk, high yield bonds typically offer a more attractive yield than an investment grade corporate bond of the same maturity.
- The MILES Bond Portfolio – Municipal offers exposure to municipal bonds through a laddered approach. Municipal bonds typically offer a tax benefit in that interest payments are typically exempt from federal taxes and may be fully or partially exempt from state taxes. Municipal bonds may make sense for an investor in a high tax bracket.
Whether an investor wants to gain exposure to one MILES Portfolio or all three, working with a Wealth Manager at WrapManager can help you navigate challenging fixed income markets by offering a unique solution designed to address the drawbacks of a traditional bond ladder and the drawbacks of a bond mutual fund or traditional ETF.
To learn how the MILES Bond Portfolio could benefit your investment plan, request your custom Investment Proposal by filling out this short form. After your submission, a Wealth Manager will reach out to you to complete the process.
Exchange Traded Funds (ETFs) are subject to market risk, including the possible loss of principal. The value of the portfolio will fluctuate with the value of the underlying securities. ETFs may trade for less than their net asset value. Investors should consider an ETF's investment objective, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other important information, is available from your Financial Advisor and should be read carefully before investing.
Diversification does not ensure a profit and may not protect against loss in declining markets. Investors should refer to the individual ETF prospectus for a more detailed discussion of the specific risks and considerations for an individual ETF. ETFs may have underlying investment strategy risks similar to investing in commodities, bonds, real estate, international markets or currencies, emerging growth companies, or specific sectors. When investing in bonds, it is important to note that as interest rates rise, bond prices will fall. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating. The values of “high yield” bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods. Municipal securities are subject to the risk that legislative or economic conditions could affect an issuer’s ability to make payments of principal and/ or interest.
The information presented by WrapManager, Inc. is general information only and does not represent tax or legal advice, either expressed or implied. You are encouraged to seek professional tax advice for income tax questions and assistance. WrapManager, Inc. does not advise on any income tax requirements or issues.
This material is not intended to be relied on as a forecast, research or investment advice, and is not a recommendation, - or solicitation to buy or sell any securities or to adopt any investment strategy. It is in no way a solicitation or an offer to sell securities or investment advisory services except, where applicable, in states where we are registered or where an exemption or exclusion from such registration exists.
Strategy descriptions listed represent a brief outline of the portfolio’s objective. There is no guarantee that any manager or product will be successful in achieving the objective described. The strategy or strategies described herein are not suitable for all investors. This material does not represent a personalized recommendation and does not reflect individual investor’s risk and return goals nor does it serve as the receipt of, or a substitute for, personalized advice from WrapManager, Inc. or any other investment professional. Prior to selecting an investment option, it is important you discuss the manager with your financial advisor. Your financial advisor can help you determine proper suitability constraints and objectives as determined from your individual needs and circumstances.
These strategies do not represent a complete list of all investment categories or managers available nor do they represent a complete list of managers or styles that WrapManager recommends to clients. They are being presented for informational and comparison purposes only. Performance of other strategies utilized by WrapManager, Inc. may not be comparable to the performance of the strategies presented in this report. Past performance is no guarantee of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for your investment portfolio.
Information pertaining to WrapManager, Inc. and Money Managers’ operations, services, and fees are set forth in the respective firms’ disclosure statements, copies of which are available upon written request. No part of this article may be reproduced in any form without the express written permission of WrapManager, Inc.© Copyright 2018, WrapManager, Inc. All rights reserved