Vanguard’s finally climbing its way up the ladder.

The world’s second-largest issuer filed this week to launch 10 corporate bond ladder ETFs, years after products from top competition like BlackRock and Invesco. The new defined-maturity funds package bonds with similar face values and end dates into a single product and give advisors a way to plan for major life events, like paying for college or funding retirement. The Vanguard funds have maturity dates between 2027 and 2036 and will look to undercut the competition on price at just 8 basis points, according to a filing with the SEC. It’s the latest addition in a flurry of new products launched this year under new-ish CEO Salim Ramji, and will enter a busy space where competitors have already planted flags, billboards and possibly lawn furniture.

“Vanguard pioneered the index fund, but they have rarely been first movers on ETFs,” said Jeff De Maso, editor of the Independent Vanguard Adviser. “Generally, they’ve been late to the game, and ultimately won through lower fees and their reputation.”

Can iShare Some of That?

Bond ladders have advantages over traditional funds because they provide a consistent cash flow over time. They can also give clients the “peace of mind” that comes with seeing them as a holding in their brokerage account, and knowing they’re going to mature at par, even if interest rates rise and bond prices dip, De Maso said.

Scott Van Den Berg, CFP, of Century Management said the real joy is lining them up with future cash needs. For example, Van Den Berg built ladders to help clients bridge the gap between retirement and the start of Social Security. “Investors aren’t familiar with how individual bonds trade or how they behave, so the simplicity of a laddered ETF will be appealing,” he said. “They give us the precision, flexibility, and confidence that each rung of the ladder is doing exactly what the client needs it to do.”

With Vanguard entering the fray, costs will almost surely come down and help investors avoid the sometimes opaque pricing found in the individual-bond market, said Mike Casey of AE Advisors. Vanguard will face entrenched competition:

• BlackRock’s iShares has a suite of iBonds funds covering corporates, Treasuries, TIPS, munis and even junk bonds that first debuted in 2010.
• Invesco added nine new target-maturing municipal bond funds to its BulletShares suite in 2019.

Step by Step. Bond ladders are also practical ways to manage interest-rate risk and bring structure to the fixed-income side of a portfolio, said Casey. But building them using an individual-bond approach requires a lot of time and attention to maintain spreads and rebalance or reinvest proceeds. That’s why the new wave of ETFs could be game-changing. “The emerging competition, now including Vanguard, should further compress expense ratios and improve liquidity, which ultimately benefits everyone,” Casey said.

Ready or not, 401(k) world, dual share classes are coming.

F/m Investments filed last Friday for the first mutual-fund share classes of ETFs, a bridge the company hopes to use to gain access to retirement plans. It represents one of the first prospectuses brought to the Securities and Exchange Commission for product-specific dual-share-class approvals. And it follows the regulator’s approval last week for an exemption requested by Dimensional Fund Advisors, which is the only firm so far to get the green light. F/m had not received that broad approval from the SEC as of Tuesday, though the company anticipates it soon.

“It’s strange that we’re talking about this accountancy issue as being interesting, but it really is,” F/m CEO Alex Morris said. In approving exemptions, the SEC has asked asset managers to file for dual share classes of all their funds, leaving it up to funds’ boards to decide which individual strategies should get either an ETF or mutual fund share class. “This is a really elegant way for fund boards and issuers to get products out there,” Morris said.

Track Racing

The big advantage for F/m is being able to port existing ETF strategies to mutual funds. Until now, firms have had to introduce separate products to accomplish that, and a drawback is that the performance history doesn’t necessarily count in the new vehicle. For 401(k) plan fiduciaries, that often means the new funds can’t be added to their menus, as they tend to look at three- or five-year track records in vetting investment options. With the mutual fund share class, the performance history of the ETF is there in writing, and the funds have the benefit of existing levels of scale, Morris said.

Despite the company filing for dual share classes of its roster of existing products, it is planning to add only two mutual fund share classes of existing ETFs initially, along with one ETF share class of a current mutual fund. The firm, which has over $18 billion in assets under management, expects to offer the strategies of its US Treasury 3 Month Bill ETF (TBIL) and Ultrashort Treasury Inflation-Protected Security ETF (RBIL) as mutual fund shares, Morris said.

The company is also broadening its product set, separate from the dual share class issue:

• Over the summer it launched a series of passive fixed-income funds with the goal of avoiding taxes associated with dividends.
• It recently filed for a line of investment-grade corporate bond ETFs with maturities ranging from six months to 30 years. It’s also prepping an “opportunistic income” ETF.

Against the Current: Most of the dozens of applicants seeking dual share classes are planning to extend their mutual fund strategies to ETFs, which makes sense, given the flows out of mutual funds and into ETFs broadly. F/m is among those going the other way. “The thing that might save the mutual fund, believe it or not, is the ETF,” Morris said. “That was supposed to kill it.”

Some people just hate surprises.

Defined outcome ETFs, which minimize downside risk but place caps on potential gains, are on track to surpass $334 billion in assets by 2030 from just $69 billion today, according to Cerulli’s latest report. The rapid growth is attributable in part to an aging US population, as baby boomers near or reach retirement and try to limit risk in their portfolios. The shift could have profound implications for the future of retirement planning and the evolving ETF landscape.

“People are living longer,” said Greg Stumm, CEO of American Beacon Partners. “Because people’s investment time horizons are expanding, and their time in retirement is expanding, they need more equity exposure. But they can’t afford a lot of the big drawdown risk.”

Predictability Sells

Defined outcome products have several characteristics that make them attractive to older investors and those with a lower risk tolerance. For one, they can dampen volatility while providing exposure in volatile areas, like small cap stocks, emerging markets and cryptocurrencies. This can make unstructured outcomes more structured, said Jeff Schwarte, chief equity strategist at Simplify Asset Management. “We’re constantly asked, ‘What are your return expectations for the market?’ And it’s really, really hard to come up with a number,” Schwarte said. “When you start using derivatives, such as options, futures, swaps, you can take the uncertainty and make it more defined.”

Other findings from the Cerulli report include:

• Two firms, Innovator and First Trust, control more than 75% of the defined outcome ETF market.
• There are currently 28 firms with defined outcome products, which include everything from dual directional ETFs to those with a 100% downside buffer.

Long Live the Buffer. There are about 10,000 baby boomers retiring every day, which means plenty of room for buffers to grow, especially as people live longer. Still, risk-on products are better suited for those with more time to spare, Stumm said. “If you’re on a longer time horizon, a 40- to 50-year horizon, the attractiveness of downside protection may seem like it makes sense, but over a longer time horizon, the downside can be problematic,” he added. “For the right client, it makes sense.”