Investing in bond Exchange-Traded Funds (ETFs) explained: A step-by-step guide on purchasing these financial assets for potential growth.

In a significant development for the UK investment landscape, bond Exchange Traded Funds (ETFs) with a fixed maturity date are now becoming available. These innovative investment products, also known as defined maturity or bullet maturity ETFs, combine the predictability of an individual bond's final maturity with the diversification and liquidity benefits of an ETF structure.

Unlike traditional bond ETFs, fixed maturity date bond ETFs hold a diversified portfolio of bonds that all mature in a specific year. For example, Betashares Defined Income Bond ETFs pay a fixed monthly income reflecting the yield of the underlying bonds and return the net asset value to investors at the fund's maturity, when the ETF is wound up. Invesco's BulletShares ETFs work similarly, offering targeted exposure to bonds with set maturities, allowing investors to build laddered portfolios to manage interest rate risk.

The behaviour of fixed maturity date bond ETFs is more akin to owning a portfolio of bonds that mature at the same time, providing more predictable cash flows and principal return at maturity than traditional bond ETFs. This contrasts with individual bonds, where you own a single issuer's debt with fixed coupons and principal repayment, and traditional bond ETFs, which provide continuous exposure to interest rate changes due to the rolling nature of their underlying bonds.

The table below shows a comparison of the key features of fixed maturity date bond ETFs, individual bonds, and traditional bond ETFs:

| Feature | Fixed Maturity Date Bond ETFs | Individual Bonds | Traditional Bond ETFs | |-----------------------------|---------------------------------------|-----------------------------------------|----------------------------------------| | Maturity structure | Set maturity date for the ETF itself | Single bond with fixed maturity | No fixed maturity; rolling portfolio | | Price stability near maturity| Prices tend to converge to par as maturity approaches, similar to bonds | Price converges to par at maturity | Prices fluctuate with interest rates | | Income payments | Distributes interest income monthly or periodically, based on holdings | Fixed coupon payments | Distributes income based on portfolio | | Liquidity | Highly liquid on exchanges, more so than individual bonds | Generally less liquid, especially for smaller issues | Highly liquid on exchanges | | Interest rate risk | Reduced as ETF nears maturity | None at maturity if held to maturity | Ongoing exposure with no maturity date | | Diversification | Diversified portfolio of bonds maturing at the same time | Single issuer risk | Broad diversified portfolio |

If a 10-year gilt was bought in July 2010, the yield would have been around 3.5%, resulting in an annualized return of approximately 7.7% per year due to holding bonds bought at higher yields that had risen in value. However, if the same 10-year gilt was bought in November 2014, the yield would have been around 2.1%, resulting in an annualized return of 2.1%. In comparison, if a 10-year gilt was held until now, the total return, including interest payments, would be approximately -0.5% per year due to a fall in the market value. This fall in the ETF's market value is because it holds many bonds that were bought on lower yields and are now worth less due to rising interest rates.

It is important to note that there are fewer long maturity options available in the UK compared to the US. iShares lists 38 fixed maturity bond ETFs in the UK, covering US Treasuries, dollar and euro corporate bonds, and Italian government bonds. DWS has 12 euro corporate trackers, Amundi has 4 euro government bond funds, and Invesco has 25 dollar and euro funds branded as Bulletshares. The iShares Treasury iBonds are the only fixed maturity bond ETFs that look useful so far.

These fixed maturity bond ETFs could be a useful tool for fine-tuning the bond exposure in an ETF portfolio. They offer a hybrid between individual bonds and traditional bond ETFs: they provide the benefit of diversification and ETF liquidity, along with a known maturity date that helps reduce interest rate risk as the maturity approaches, making their price behavior converge towards par like individual bonds. Traditional bond ETFs provide more ongoing exposure and flexibility but do not have the same final maturity structure and therefore behave differently in response to interest rate changes.

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Investing in fixed maturity date bond ETFs, such as Betashares Defined Income Bond ETFs or Invesco's BulletShares ETFs, can offer predictable cash flows and principal return at maturity, providing more stability than traditional bond ETFs.
These innovative investment products combine the benefits of individual bonds with the diversification and liquidity benefits of an ETF structure, allowing investors to manage interest rate risk and build laddered portfolios.
In the UK, the behavior of fixed maturity date bond ETFs is more akin to owning a portfolio of bonds that mature at the same time, contrasting with individual bonds or traditional bond ETFs that have continuous exposure to interest rate changes.
For businesses or individuals looking to invest, fixed maturity date bond ETFs can serve as a useful tool for fine-tuning bond exposure in an ETF portfolio, offering a hybrid between individual bonds and traditional bond ETFs, providing diversification, ETF liquidity, and a known maturity date.

Investing in bond Exchange-Traded Funds (ETFs) explained: A step-by-step guide on purchasing these financial assets for potential growth.