Bond fund with specific maturity dates

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Carterman32
Posts: 4
Joined: Sun Feb 23, 2014 5:54 pm

Bond fund with specific maturity dates

Post by Carterman32 » Tue Sep 11, 2018 9:42 pm

I know this has been covered in other posts, but I am still unclear.

I am looking at laddering bond funds with specific maturity dates, but I do not understand how YTM can change when the fund is meant to be held the end of maturity.

For example, BSCK, which has a 2020 maturity, lists:

30 day sec yield: 3.11%
Distribution yield: 2.21%
Avg coupon: 3.34%
Yield to worst: 3.14%
Yield to maturity: 3.14%
12 month distro rate: 1.97%

There are so many numbers here, it makes my head spin. My understanding is that, unless someone calls bonds - and thus, they have to be replaced - the fund holds a specific number of bonds through the 2020 maturity date, at which point the fund liquidates. In the prospectus it says you can expect distributions to be lower in the final year as the bonds come to maturity and are held in cash.

Can someone clarify the following:

1) If I'm holding to maturity, and the Avg coupon is 3.34%, should I be expecting a 3.34% return minus the .10 management fee?
2) What does YTM matter when the Avg coupon is 3.34%? And why is YTM lower than Avg coupon? If I'm holding to maturity, why would the YTM be different from Avg coupon?
3) Why is the 12 month distro rate 1.97%? That's well below year to maturity? I'm unclear.

Grt2bOutdoors
Posts: 19295
Joined: Thu Apr 05, 2007 8:20 pm
Location: New York

Re: Bond fund with specific maturity dates

Post by Grt2bOutdoors » Tue Sep 11, 2018 10:06 pm

Carterman32 wrote:
Tue Sep 11, 2018 9:42 pm
I know this has been covered in other posts, but I am still unclear.

I am looking at laddering bond funds with specific maturity dates, but I do not understand how YTM can change when the fund is meant to be held the end of maturity.

For example, BSCK, which has a 2020 maturity, lists:

30 day sec yield: 3.11%
Distribution yield: 2.21%
Avg coupon: 3.34%
Yield to worst: 3.14%
Yield to maturity: 3.14%
12 month distro rate: 1.97%

There are so many numbers here, it makes my head spin. My understanding is that, unless someone calls bonds - and thus, they have to be replaced - the fund holds a specific number of bonds through the 2020 maturity date, at which point the fund liquidates. In the prospectus it says you can expect distributions to be lower in the final year as the bonds come to maturity and are held in cash.

Can someone clarify the following:

1) If I'm holding to maturity, and the Avg coupon is 3.34%, should I be expecting a 3.34% return minus the .10 management fee?
No. It's the yield to maturity of 3.14% less the management fee of .10 or 3.04%, assuming management does actually hold the bonds until maturity.
2) What does YTM matter when the Avg coupon is 3.34%? And why is YTM lower than Avg coupon? If I'm holding to maturity, why would the YTM be different from Avg coupon?
It matters because that is the actual amount you will receive over the remaining life of the fund.
A higher average coupon rate suggests to me that the fund is holding bonds yielding more but trading at a premium.
That premium is amortized (reducing its value) over the life of the fund so that at maturity, the fund will receive par or $100. Today the bond could trade at 102, at maturity it will have decreased in price until it's at par or $100. That results in a lower yield to maturity as negative amortization reduces the actual total return received.

3) Why is the 12 month distro rate 1.97%? That's well below year to maturity? I'm unclear.
If you clicked on the link next to the rate, you'd see that the rate is a function of the prior twelve months interest and dividends received divided by the current net asset value.
Did you look at the actual holdings of this fund? Do you think that all of the holdings come due for maturity in 2020? I looked at it and saw some of the holdings don't actually mature until much later, like 2025 and a number of the holdings are callable.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

Carterman32
Posts: 4
Joined: Sun Feb 23, 2014 5:54 pm

Re: Bond fund with specific maturity dates

Post by Carterman32 » Tue Sep 11, 2018 10:18 pm

Did you look at the actual holdings of this fund? Do you think that all of the holdings come due for maturity in 2020? I looked at it and saw some of the holdings don't actually mature until much later, like 2025 and a number of the holdings are callable.
How can a fund whose assets are supposed to all reach maturity in 2020 have assets that go to 2025? That makes no sense and defeats the purpose of the fund. The fund is supposed to be completely liquidated at the end of the term, and only filled w assets ending in that term. That's why people use these funds to ladder.

Grt2bOutdoors
Posts: 19295
Joined: Thu Apr 05, 2007 8:20 pm
Location: New York

Re: Bond fund with specific maturity dates

Post by Grt2bOutdoors » Tue Sep 11, 2018 10:26 pm

Carterman32 wrote:
Tue Sep 11, 2018 10:18 pm
Did you look at the actual holdings of this fund? Do you think that all of the holdings come due for maturity in 2020? I looked at it and saw some of the holdings don't actually mature until much later, like 2025 and a number of the holdings are callable.
How can a fund whose assets are supposed to all reach maturity in 2020 have assets that go to 2025? That makes no sense and defeats the purpose of the fund. The fund is supposed to be completely liquidated at the end of the term, and only filled w assets ending in that term. That's why people use these funds to ladder.
Call up Invesco and ask. The first thing to do before contemplating a purchase is to read the prospectus that details what can and can not be purchased. Usually they include everything under the sun including the kitchen sink so that most securities within reason can be fair game. Second, the reason why is because they need the yield to be a certain amount or they see a security that has been mispriced and they are seeking to arbitrage it or the bond is callable by the issuer by a certain date close to the target date. Though it being callable doesn't mean that it actually will be called before maturity, meaning you could theoretically lose money if you needed to sell before final maturity.

If you want a target that matures in exactly 18 months, my suggestion to you is not to get fancy, buy a fixed term certificate of deposit that matures when you want it to and without having to be concerned with what's in the fund and if your are going to get your money back.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

AlohaJoe
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Re: Bond fund with specific maturity dates

Post by AlohaJoe » Tue Sep 11, 2018 10:37 pm

Carterman32 wrote:
Tue Sep 11, 2018 10:18 pm
Did you look at the actual holdings of this fund? Do you think that all of the holdings come due for maturity in 2020? I looked at it and saw some of the holdings don't actually mature until much later, like 2025 and a number of the holdings are callable.
How can a fund whose assets are supposed to all reach maturity in 2020 have assets that go to 2025? That makes no sense and defeats the purpose of the fund. The fund is supposed to be completely liquidated at the end of the term, and only filled w assets ending in that term. That's why people use these funds to ladder.
It doesn't "defeat the purpose of the fund". There's exactly one bond in the entire fund that matures after 2020. And it amounts to 0.18% of the fund. And it is callable in 2020. So it has an effective maturity of 2020, which is exactly what the prospectus for Bulletshares 2020 Corporate says they will invest in.

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Phineas J. Whoopee
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Re: Bond fund with specific maturity dates

Post by Phineas J. Whoopee » Wed Sep 12, 2018 4:19 pm

Hi Carterman32.

Often people find bonds confusing. There are basic principles, but some bonds are more complicated. I'll suggest one of our wiki pages, then provide a brief introduction to Yield to Maturity, YTM.

The wiki page is Bond basics.

Often here misunderstandings boil down to people not realizing the word yield does not mean the amount of money the bond pays out periodically prior to the day it matures. That's called the coupon. Yield, which has variations, means something else entirely.

Coupons don't take present market prices into account. Yields do. Allow me to explain.

If you buy a $1000 face-value bond with a 3% coupon, it will pay $15 every six months until it matures, then finally the original $1000. This takes place whether or not you paid exactly $1000. You might have paid more or less, but the coupon and final maturity payout stay the same.

Yield, which if not otherwise specified conventionally means Yield to Maturity, YTM, takes the present market price of the bond into account. As the price fluctuates, so does YTM.

There are three YTM components that all work together:

1) The coupon payments;
2) Reinvesting the coupons as you receive them; and
3) The inevitable convergence of a bond's market price with its face value as it approaches maturity. Who would pay much more, or accept much less, than $1000 for a $1000 face value bond that matures tomorrow?

If an investor buys a bond today, on the primary or secondary market, their YTM is calculated based upon today's market price for the bond. That's the yield, including all three elements, they will obtain if they hold and reinvest coupons until the bond matures. Tomorrow's market price may be different. The person who purchased already will, if holding to maturity and barring default, end up with what YTM was, but on the next day YTM has changed.

To recap, I think two points about bonds that frequently get missed are the difference between coupon, which doesn't depend on current price, and yield which does; and the fact that bonds trade on a market and have fluctuating prices.

I hope that helped.

PJW

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