Frankfurt. More and more companies are financing themselves on the euro bond market and offering high interest rates. The travel portal Booking.com recently issued new bonds from the USA, and the British bank Barclays and the German industrial gases group Linde are among the current issuers from Europe. They offered returns of significantly more than four percent for their securities with terms of five to seven years.
However, private investors are left out. Most companies reserve their bonds with a minimum investment amount of 100,000 euros for institutional investors. Small investors have long been able to buy bonds through inexpensive exchange-traded funds (ETFs). But the real charm of bonds - the annual return that you can expect from the time of purchase until the bond matures - is lost.
The reason: With bonds, the return results from the interaction of the interest payments over the term, the purchase price and the repayment price of 100 percent. Unlike the bonds themselves, ETFs do not have a fixed end term. This means that in order to make a profit with bond ETFs, the prices of the bonds in the fund must rise or at least not fall so much that they eat up the interest payments.
For a good three years now, there have also been exchange-traded funds (ETFs) for corporate euro bonds, with which investors can pursue a buy-and-hold strategy. These ETFs are becoming increasingly popular. Investors have now invested more than 15 billion euros in iShares alone, the ETF division of the fund house Blackrock. Paul Jung from Blackrock sales recently said this in a podcast with the Frankfurt Stock Exchange.
According to Jung, the ETFs are bought not only by private investors, but also by institutional investors. Handelsblatt explains what investors need to know about bond ETFs with fixed maturity dates.
Like bonds themselves, term ETFs have a maturity date at which investors get their money back. Most term ETFs come in accumulating and distributing versions. ETFs are offered with remaining terms ranging from a few weeks to a good eleven years. The largest provider after iShares is the ETF division of DWS called Xtrackers.
Anyone who allows the interest payments to accrue on bond-term ETFs will ultimately receive the fund back at the issue price plus interest. Alternatively, investors with term ETFs can have the interest paid out four times a year. Then, at the end of the term, they receive their funds paid out again at the issue price. Unlike buying bonds directly, there can be deviations of a few cents up or down, according to Jung.
Portfolios change
The fact that the repayments and, above all, the returns of the term ETFs are not quite as easy to calculate as the bonds themselves is because the composition of the bonds in the ETF changes. The ETF portfolios reflect indices that the index specialist MSCI and the information service Bloomberg have constructed for the providers.
Only bonds that mature in the same year are included in the indices and ETFs. Since banks issue the most bonds, they have the largest weight in the ETFs. But all other sectors are also represented.
The indices and portfolios are reviewed once a month. There are four main reasons for changes.
The bonds in the indices and ETFs do not mature on the same day that the term funds are liquidated and investors are paid out, but rather several months beforehand. The money from the bonds that expire before the deadline is invested in very short-term German and French money market securities. There is no risk of default, but it is impossible to say in advance what returns the money freed up through the repayments will be invested in the short term.
The portfolios change because more and more bonds are taken in over time. iShares' term fund, launched in August 2024 and due in December 2029, now contains almost 400 different bonds. The ETF, which was launched last May and runs until December 2036, only contains a good 70 bonds so far. This is because European companies in particular tend to choose medium maturities for their bonds. Depending on the respective market environment, the bonds that are gradually added to the ETFs offer higher or lower returns than the bonds previously included in the fund.
It happens that bonds no longer fit the ETF. Most term ETFs only accept bonds from companies that the rating agencies attest to have excellent to fair creditworthiness in the investment grade range and assign credit ratings between “AAA” and “BBB-”.
If a company falls below this threshold, the bonds fall out of the index and must be sold. This usually happens with price losses because bond prices fall after a downgrade. The risk of companies falling out of an index due to poor creditworthiness cannot be ignored. Almost half of the bonds in the term ETFs have ratings in the “BBB” range.
Bonds can also drop out of a portfolio early if companies pay them back before their official maturity. Some companies give themselves this opportunity.
Hardly any risk of failure
However, the risk that bonds in the ETF portfolios will default and therefore reduce returns is very low. According to Jung, in the past 20 years there have only been two cases in which euro-denominated bonds from companies with investment grade ratings were defaulted. The financial crisis involved bonds from the US bank Lehman Brothers and, in 2020, the bonds from the scandal-ridden payment service provider Wirecard.
The broad diversification also prevents even an unlikely default from significantly reducing returns. This also applies because individual companies in the ETFs may have a maximum weight of three percent.
However, term funds for bonds are not as safe as overnight or fixed-term deposits. Jung von Blackrock also emphasizes this. The term ETFs, which iShares calls iBonds, are a capital market product. There is no deposit protection like there is with overnight and fixed-term deposits, and during their term the prices of the ETFs fluctuate with the prices of the bonds on which they are based.
Investors can ignore exactly these fluctuations with term ETFs because they are paid out again at a fixed time. And if you need the money before the maturity date, you have the option of selling the ETFs on the stock exchange.
Conclusion: Bond-term ETFs cannot exactly reflect the advantages of investing in individual bonds. Investors can use them to invest easily and broadly in bonds, and at low fees. Although the expected return cannot be predicted exactly, the maturity date makes the investment more predictable than with traditional bond ETFs.
