ETF Expert Corner

Guggenheim’s Bill Belden Explains BulletShares ETFs, Offers Perspective on Rate Environment

April 25th, 2017 by ETF Store Staff

Bill Belden, Managing Director at Guggenheim, highlights the BulletShares lineup of ETFs and offers his perspective on the current interest rate/credit environment.

Play


Transcript

You can listen to our interview with Bill Belden by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: I am now very pleased to welcome to the program Bill Belden, Managing Director at Guggenheim. Guggenheim is a top 10 ETF provider. They currently offer over 70 ETFs with nearly $35 billion invested in those ETFs. One of the most popular suites of ETFs they offer is the BulletShares lineup of ETFs. These are target maturity bond ETFs and they'll be the focus of our conversation here today. Bill is joining us via phone from Chicago. Bill, great to have you back on the program.

Bill Belden: Nate, great to be with you. Thanks for having me.

Nate Geraci: Bill - let's talk about the BulletShares lineup. These have really grown in popularity. I saw that they took in nearly $275 million just in March alone. My guess is they'll continue to attract a lot of attention, just given the prospect of rising interest rates. Walk us through the basics here. What are BulletShares? How do they compare to traditional bond funds or ETFs? And, why do you think investors are gravitating towards these?

Bill Belden: Well, we're excited to have the success we're enjoying with the BulletShares fleet of ETFs, Nate. I think the best way to provide that answer is to go back to when the BulletShares were created and why they were created, which really served, or sought to address, the need that investors have with their choices to get fixed income exposure into their portfolios. In traditional funds – they’re offered perpetually - they don't have a maturity date. It was really tough to invest with the precision that you really need, or ideally want, in constructing fixed income allocations in a portfolio. In contrast, you could always use individual bonds as well, which have that finite life, but really offer some challenges as it relates to the ease of which you can get into and get out of those bonds. Certainly, the diversification challenges, given the amount of money that it takes to put together a diversified portfolio of bonds. The BulletShares indexes were actually created back in 2010. We launched our first ETFs in June of that year, that seek to track the performance of those indexes, which themselves provide exposure to the effective maturity of all investment grade corporate bonds in the US with an individual maturity year. We have actually within our investment grade corporate suite, we have 10 ETFs ranging in maturities from 2017 through 2026. We also have a different set of eight high yield corporate bond ETFs with maturities from 2017 to 2024. Across those 18 products, again, we're giving exposure to bonds that have maturities or effective maturities in each one of those individual years. The question we actually get is, "Well, what happens when the fund matures?". Really what happens is that over the course of the maturity year, as bonds mature and cash is sent back to the fund, that cash is held in treasury bonds until end of that particular calendar year. As that cash accumulates, it results in 100% of the portfolio being in cash at the end of December. That's the maturity date - the last business day of the year is the maturity date for the individual BulletShares ETF. We send the proceeds back to shareholders. Over the course of the past six years, we've matured 11 of these BulletShares ETFs and have sent nearly $3 billion in assets back to shareholders. The proof points are there for them working. Investors who have received proceeds from maturing BulletShares, in many cases, just turn around and put those proceeds back into BulletShares ETFs at later dated maturities. We're excited about the value proposition that the BulletShares offer, particularly as you said, in a period of rising ... or the minimum at least ... in volatility around the direction of interest rates.

Nate Geraci: Bill, you alluded to the fact that traditional bond funds or ETFs continually roll over holdings. For the layman investor, why may that be a concern?

Bill Belden: Well, there's a couple of reasons, Nate. I think one is, first of all, the investor's portfolio needs change over time, right? If you're investing in an intermediate term bond fund with a five-year duration right now, well as you continue to hold that portfolio, your needs for that duration change over time too, but the portfolio itself effectively remains the same. The five-year duration fund that you're buying into today is a five-year duration fund five years from now. You may want to have those proceeds and your need to get that money out is subject to the whims of how that particular portfolio may be positioned or priced at that particular time. The finite life of the BulletShares ETF provides for that defined maturity and that defined duration so that if I'm looking for a five-year investment horizon and I acquire a five-year BulletShares ETF, in five years, in between now and that five-year period, that duration goes down. At the end of that five years, I get that maturity and those proceeds back, which is a really attractive feature. The second point is, and it's certainly in a period of, and it's tied to the first one, but in a period of rising rates certainly bond values go down, right? When you are holding onto your bond fund and the rates go up, certainly the value of the portfolio actually goes down. Without a maturity at the end, you may not have the opportunity for those bond prices to come back by the time that you get out of it. Well, when you own something like a BulletShares ETF, again, you buy into the portfolio. For someone who's going to own that product to its maturity date, to the extent that prices go down and values are depressed, if you hold onto that as those bonds approach their maturity date, those again, absent any sort of credit events, those bonds will mature at par, and you'll get your proceeds back. It's a great way to mitigate interest rate risk, particularly now in the environment that we're in, when we're so challenged to really get a good feel for where rates are going, it's an attractive solution.

Nate Geraci: In terms of specific portfolio applications for BulletShares, a time-tested bond strategy is laddering, where you put together a portfolio of bonds with different maturity dates. Then as each "rung" of bonds matures, they can be invested at the current interest rates. For the average investor, what are some considerations when building a laddered bond portfolio? Why do you think that might be a more prudent approach in today's environment?

Bill Belden: Laddering is kind of, it's what's old is new again. You know, it was in fashion a long time ago. It kind of fell out of fashion. It's particularly being revisited with a lot of success now because of some of those attributes that I talked about, and you just kind of keyed up, in terms of providing efficient exposure to the fixed income markets. The consideration is number one, if you really want to put together a ladder, you've got to spend the time to research and find the bonds and the investments that you're going to pick. You have to do the credit analysis on it. You have to find those bonds in which you can actually acquire. The cost that goes into actually acquiring them is a big consideration. Certainly, if you're holding individual bonds, you're typically lacking in the diversification that is available to you in a broader, more broadly allocated portfolio of bonds. There's really a lot that goes into building a ladder if you want to do it with individual bonds that a solution like BulletShares can make really easy for you because, again, that portfolio is already established through the dynamic nature of the index that underlies the BulletShares ETF. The number of bonds that are held in each one of the BulletShares ETFs is typically 100 or more. Again, so a strong diversification component. All of those attributes that are related to ETFs obviously are available in BulletShares as well, where you can get into and get out of the BulletShares ETF - should you choose to do so - very efficiently. They trade with nice attractive spreads on the exchanges. We're really happy about the support that we get from our market makers. Again, execution and the time and resources that go into putting the ladder together are the biggest considerations you would have in constructing a ladder. While I'm at it, I guess I would say, certainly, we see the predominant use of BulletShares is in putting ladders together. We looked at our friends at Crescent Research, who did some research, Nate, on the performance of ladders. They went back all the way to 1900. Any 5, 7, or 10-year ladder that was put together during that period of time - from 1900 all the way through 2016 - using treasuries in this case, delivered a positive performance, positive total return performance. Not one of those. Again a 5-year ladder, a 7-year ladder, or a 10-year ladder, at any juncture and during that entire 116 year period, delivered a positive performance number. That's pretty powerful performance.

Nate Geraci: Yeah, and I should mention that the Guggenheim website, GuggenheimInvestments.com, there's actually a BulletShares ETF bond laddering tool, which can help you put together a ladder in your portfolio. Our guest today is Bill Belden, Managing Director at Guggenheim. Again, Guggenheim is a top 10 ETF provider. They do offer the popular BulletShares ETFs. Bill, we touched on many of the positives of target maturity bond ETFs - there are certainly many. What are some of the potential downsides here?

Bill Belden: I think obviously risk is something that is involved with investing. Again, I mentioned to you, Nate, that we have two suites. We have the investment grade corporate suite and we have the high yield corporate suite. Certainly, credit is a factor that goes into bond investing. Obviously, when you're putting dollars to work in buying bonds and the funds that include those bonds, certainly credit is a consideration. If there is a default event, and that's particularly applicable in the case of the high yield corporate space where credit ratings are lower for those individual bonds, credit is a risk that investors take. You can see certainly pricing volatility occur within high yield in particular at a greater level than investment grade, which in itself is greater than treasuries, of course. That's where diversification really comes into play. Any one individual bond in those portfolios by defaulting doesn't have an overly punitive effect on the performance of the portfolio, but there's certainly a risk to consider. And the other thing I talked about a moment ago, that one of the benefits is interest rate risk mitigation for the buy to own to maturity investor - if you're holding the portfolio as interest rates go up, again, you can see the value of your portfolio go down. If you're not owning that portfolio to its maturity, you can see some depressed prices in fixed income as rates rise. Recognizing that you do also have the ability to buy more bonds at higher rates as those rates are rising, of course, but that increase in income, if you will, as a result of those higher rates sometimes will not offset the loss that you incur in principal for someone who is not owning that fund to its maturity.

Jason Lank: Bill, this is Jason Lank. Welcome back to the show. On the subject of bond ETFs in general, I'd like you to address the subject of liquidity. There's chatter out in the industry that perhaps there's a mismatch between the underlying holdings and the ETFs themselves. For example, the BulletShares may be very, very liquid for the investor, but the underlying holdings ... of course, the bond market is more opaque. The concern might be that in extreme situations, whether that's buying pressure or selling pressure, you might see some dislocation in that creation/redemption process. Could you speak to that?

Bill Belden: Yeah, Jason, that's a great question. Liquidity, certainly as bond ETFs have gotten a lot more popular and grown in size, has been at the forefront of issues that are raised around investing, particularly as you get into some asset classes that are a little more thinly traded within fixed income like bank loans and like high yield, for example. Liquidity is certainly something that investors need to keep in mind. We've been very pleased with the liquidity that's available within fixed income ETFs overall, and certainly within our BulletShares. We have ETFs, which includes high yield, of course. I think that, Jason, one of the things you need to look at is the amount of trading that goes on within fixed income ETFs relative to the amount of buying and selling that is happening directly with the fund itself. You'll see some of the largest high yield ETFs, or some of the largest bank loan ETFs have significant volume numbers as it relates to the number of shares and the value of those shares traded on any particular day. The amount of activity that's actually happening directly with the fund, in other words - the number of transactions that the fund is participating in, is typically only a fraction of that. I think that if you look at what's actually happening with the fund, you'll find that liquidity has actually been a strong feature and facet of fixed income ETF investing. It is something that investors need to look at. Again, there are certainly always trading tips that you should keep in mind when executing purchases and sales in ETFs that are very helpful in supporting liquidity in execution. Some of those include, of course, using limit orders, which is something that we always recommend for investors to use when they're transacting an ETF. In setting prices around limit orders, you should always look at where the spread is on the ETF right now to make sure that relative to where that ETF typically trades, that the bid-ask spread is something that's attractive or adequate to enable you to get your order off when, again, getting into or getting out of a fixed income ETF.

Nate Geraci: We're visiting with Bill Belden, Managing Director at Guggenheim. Bill, lastly here as it relates to BulletShares, obviously the specter of rising rates could be a good reason to consider using BulletShares. I know you're not in the business of predicting future interest rate movements. We all know how difficult that is. Can you maybe just give us your general assessment of the current rate environment and maybe some factors you're keeping an eye on that could drive rates higher moving forward?

Bill Belden: Yeah, sure. As a matter of fact again, and I typically will parrot Scott Minerd, our Global Chief Investment Officer in Guggenheim, when talking about interest rate outlooks. Scott has more recently said, and has gotten some attention as it relates to the calls that he's made, that the 10-year bond - which is now in the 220s area - may head south to 1.5% yield at some point over the course of this summer or early fall as some of the shine falls off of the excitement surrounding the new administration coming in. Some of the other geopolitical risks that we see right now continuing to create a certain level of uncertainty, if you will, in expectations for global economies performing. He believes that we may be headed south here again over the relatively near term as it relates to the 10-year as a prophecy for rates in general. Certainly, something that would conflict potentially with the rising rates in areas that we've heard predominantly, particularly on the heels of the Fed raising rates a couple of times over the course of the past two quarters.

Jason Lank: Bill, obviously we're in a low interest rates environment, so I'm sure, for income investors at least, your high yield BulletShares have gotten quite a bit of attention. I'm sure positive flows. You just spoke to the interest rate component, but we know high yield is impacted by a number of factors. Another large one would be the credit side. Again, no one has a crystal ball. How do see the environment right now?

Bill Belden: Well, again, kind of using Scott's thoughts on the high yield market - he thinks that it's pretty well priced at the point right now. There's certainly some risk in high yield as it relates to valuations. Defaults will look very attractive, and certainly, we believe that the default environment is very positive coming out of some challenges for defaults within high yield that were specific to energy and some related industries and sectors within high yield. From a credit perspective, he feels pretty good about where we are right now, although high yield prices in particular are, again, fairly priced right now, and doesn't see a whole lot of near term opportunity within high yield from a return perspective. Recognizing, of course, as you said, that the yield is pretty attractive, certainly relative to some other alternatives within treasuries and investment grades.

Nate Geraci: Well, Bill with that, we will have to leave it there. As always, just a pleasure having you on the program. We certainly appreciate your time today. Thank you.

Bill Belden: Nate, Jason, great to be with you again. Appreciate the time. Have a great day.

Nate Geraci: That was Bill Belden, Managing Director at Guggenheim. You can learn more about their ETF lineup by visiting GuggenheimInvestments.com.