Defined Maturity Funds: Is It a Bond, A Fund, Or Both?
In a previous post, we discussed the most common types of investment funds: mutual funds and exchange-traded funds (ETFs). This review focuses on a specific category within both mutual funds and ETFs: defined maturity funds. A defined maturity fund is a fund with a specified end date, usually indicated in the fund’s name. For example, a “2030 fund” is designed to liquidate and return all assets to investors in the year 2030, meaning all assets must be sold by or before the fund’s maturity date. Apart from the predefined closing date, these funds operate similarly to those without defined maturities. This structure has gained popularity, especially in asset classes with specific maturities, such as fixed income.
Characteristics of Defined Maturity Funds
Defined maturity funds share characteristics with defined maturity securities like bonds. A 2025 investment grade bond fund, for example, will exhibit similar features and behavior to an individual investment grade bond maturing in 2025. This fund structure allows investors to buy a diversified portfolio of bonds maturing around the same time, providing the benefits of diversification and reduced credit risk compared to holding a single bond from one issuer.
Bond Prices and Interest Rates
To recap, bond prices move inversely with interest rates. Rising interest rates lead to falling bond prices and vice versa. The time remaining to maturity, or tenor, affects a bond’s price sensitivity to interest rate changes. Bonds with longer maturities are more susceptible to interest rate risk, while shorter-maturity bonds face reinvestment risk if rates fall, leading to lower yields on reinvestment. Predicting interest rate movements is notoriously challenging. One strategy to mitigate interest rate risk is to construct a “laddered” bond portfolio, with bonds maturing at regular intervals. For instance, an investor could buy bonds maturing in 2025, 2026, 2027, and so forth, creating a laddered portfolio that is liquid and less exposed to interest rate risk than a standard fixed income mutual fund. Defined maturity bond funds enable precise maturity targeting within a diversified bond portfolio, aiding in the construction of laddered portfolios to match cash flow needs and distribute interest rate risk across various maturities.
Benefits of Defined Maturity Bond Funds
When interest rates rise, individual bondholders see their bonds’ value decline but can avoid realizing the loss by holding bonds to maturity, assuming no default. Building a diversified portfolio of individual bonds is often impractical for individual investors without substantial assets, which is where defined maturity bond funds become valuable. These funds typically hold hundreds to thousands of bonds, most set to mature around the stated maturity date. At the fund’s end date, net assets are distributed to investors, akin to a bond returning principal at maturity. Defined maturity bond funds offer diversification and liquidity benefits that individual bondholders may lack, as trading a diversified fund is generally easier and faster than trading individual bonds.
Investment Opportunities in Defined Maturity Funds
Defined maturity funds are currently available across investment grade, high yield, and municipal bond sectors, offering a structured approach for investors managing interest rate risks and seeking predictable cash flows. These funds mimic individual bonds with specific maturity dates, providing diversification and liquidity advantages over managing individual bonds or complex portfolios. Despite potentially higher implementation costs compared to broad index bond funds, defined maturity funds are an appealing solution for managing interest rate risk and delivering predictable cash flows aligned with specific time horizons.
For business owners or retirement plan participants with questions about maturity funds, contact Empirical Wealth Management. We’re here to guide you through your investment options and help you achieve your financial objectives.
