IBHF Or 3-YR CD: I’ve Decided Which Is Better

Introduction

While I know exceptions, my 92 year old father for one, most of us retired folks want fixed income assets that help balance out the risk we are willing to take with our equity allocation. What the split might be was explored in another article I wrote just after entering retirement myself. For me, with my low equity allocation, I am willing to take extra risks with my fixed income assets to enhance my returns but also to generate cash to cover my RMDs without the need to sell or transfer a holding.

Along with holding BDCs in my IRA for income generation, I laddered about 20 baby bonds and term preferreds for the same purpose and better yields than safe CDs provide. I have considered vehicles like iShares iBonds 2026 Term High Yield and Income ETF (BATS:IBHF), but most had two, maybe three flaws as I analyzed them:

• A low yield that doesn’t justify the extra risk the ETF has over a CD.
• Too many bonds that matured after the fund’s termination date, resulting in the ETF being exposed to interest-rate risk.
• The right to extend the funds life or even totally eliminate the termination.

iShares iBonds 2026 Term High Yield and Income ETF review

IBHF has $152m in AUM and investors incur 35bps in fees. The TTM Yield is 7.35%.

Seeking Alpha describes this ETF as:

The iShares iBonds 2026 Term High Yield and Income ETF was launched by BlackRock, Inc. The fund is managed by BlackRock Fund Advisors. It invests in fixed income markets of the United States. The fund invests in U.S. dollar-denominated, taxable, fixed-rate, high yield corporate bonds that are rated equal to or below Ba1, BB+, BB+ and above CC by Moody’s, S&P and Fitch respectively and BBB or equivalently rated corporate bonds, scheduled to mature between January 1, 2026 and December 15, 2026. The fund seeks to track the performance of the Bloomberg 2026 Term High Yield and Income Index. The ETF started in 2020.

Source: seekingalpha.com IBHF

Index review

The index is composed of U.S. dollar-denominated, taxable, fixed-rate, high yield (which are considered below investment-grade) and BBB or equivalently rated corporate bonds scheduled to mature between January 1, 2026 and December 15, 2026, inclusive. The bonds in the Underlying Index have $250 million or more of outstanding face value at the time of inclusion. The Underlying Index will be subject to issuer limits of 3%, with any excess redistributed among the remaining constituents on a pro-rata basis. The securities in the Underlying Index are updated on the last calendar day of each month until six months before maturity, with the last rebalance date on June 30, 2026. More details are available in the ETF’s Prospectus.

End-of-life review

This covers what the ETF options are at its termination date, one of the three concerns I have for ETFs that are schedule to end.

The Fund will wind up and terminate on or about December 15, 2026. Upon its termination, the Fund will distribute substantially all of its net assets, after making appropriate provision for any liabilities of the Fund, to then-current shareholders pursuant to a plan of liquidation. In the final months of the Fund’s operations, as the bonds it holds mature, its portfolio will transition to cash and cash equivalents. To the extent that the Fund invests in money market or similar funds, it will incur the fees and expenses of such funds. By December 15, 2026, the Underlying Index value will be represented almost entirely by cash as no securities will remain in the Underlying Index. In accordance with the Trust’s current Agreement and Declaration of Trust, the Fund will terminate on or about the date noted above, as approved by a majority of the Trust’s Board of Trustees (the “Board”), without requiring additional approval by Fund shareholders. The Board may extend the termination date if a majority of the Board determines the extension to be in the best interest of the Fund.

Source: ishares.com IBHF Prospectus

As explained in the Prospectus, in the final year of the Underlying Index’s term, any principal and interest paid by index constituents is treated as follows: (1) during the first six months of the final year, the Underlying Index reinvests proceeds pro-rata into the remaining bonds in the Underlying Index, and (2) during the last six months of the final year, proceeds are not reinvested and are presumed to be held in cash while earning no interest. Since the ETF invests based on the Index, I would assume IBHF will do the same.

The Prospectus lists that during the six month pre-termination period, the Fund’s yield will generally tend to move toward prevailing money market rates as maturing bonds are not reinvested into new bonds. The lack of that occurring would appear to indicate that the Trustees have decided to extend the ETF’s life. Unlike others I have reviewed that require shareholder votes or a maximum on the extension, I did not see either here. That said, the whole purpose of the ETF would need to be restated.

There were three ETFs in this series (2020-22) that all terminated on schedule, so I rate concern #3 as very unlikely.

Holdings review

Important facts about the portfolio before I did deeper into the holdings include the following:

• Number of bonds: 224, down 8 from 9/30/23
• Yield-to-Maturity: 9.11%
• Weighted Average Coupon: 6.29%
• Weighted Average Maturity: 2.44 years, down from 2.57 on 9/30/23 (ETF closes in 3)
• Effective Duration: 2.03 years

Along with holding over 200 bonds to be diversified, the sector weights are not highly concentrated.

One concern might be many of the top sectors rely on a strong economic background, something that cannot be known for when the bonds start maturing in 2026. That said, investors cannot take too much comfort in the next chart, which shows the ratings of what is held.

Morningstar gives an overall rating of “B” to the portfolio. While B-rated bonds have a higher default rate than BB, it is the CCC-rated ones I have concern with as their 5-yr default rate is almost 50%! That weighting is also up from 9.2% over the past year. As expected/required, all bonds mature in 2026, with a monthly breakdown shown later.

Top 20 holdings

Just over 25% of the portfolio is held within the Top 20 bonds, out of the 224 held. It takes the 50 smallest positions to equal 10% of the portfolio weight. All bonds are denominated in USD so there is no currency risk.

With the ETF investing based an index that also terminates at the end of 2026, concern #2, interest-rate risk has been eliminated.

There is some risk the ETF could be hurt by defaults with the amount of below B-rated bonds held. The data on the iShares site did not include how each bond is currently rated. That said, based on the YTM/coupon ratio, I would suspect several in this list have issues that concern the market.

Distributions review

FOMC actions have helped push up payouts since early 2022, though that uptrend has stalled since last spring. If the FOMC stops hiking, IBHF might be near the peak in its payout levels. If the ETF indeed starts its shutdown process as described above, payouts could start declining by the summer 2026.

Portfolio strategy

Going on the expectation that the IBHF ETF termination in the middle of December 2026 will occur, its expected return, as measured by its Yield-to-Maturity can be compared against CD’s maturing about the same time. Currently 3-Yr CDs are yielding around 5.5%. While IBHF is yielding more than that, the real data point of concern is the ETF’s YTM, which is even higher at 8.87% as the average bond held is currently selling for $93.81. Of course, all those values will change as the ETF adjusts its portfolio between now and the start of its potential termination in three years hence. The current holdings by month in the year 2026 indicate what percent of the ETF would need to be reinvested into bonds maturing later in 2026 or held in short-term T-bills or something else equally safe.

Investors need to keep in mind that YTM is based on current holdings and the ETF is experiencing a 15% turnover rate. Beside portfolio repositioning, changes in AUM, coupon payments, and bond calls all feed into that 15% figure. The point being, the YTM is not a guaranteed value. Taking that warning into account, the decision to own IBHF comes down to concern #1: Is the risk of owning an ETF with an average bond rating of B, a top-level non-investment-grade rating, worth the extra 3.37% anticipated annual return over what a 3Y CD yields?

Thanks to the fact that IBHF’s AUM has tripled over the past year, the ETF has added $100m in bonds whose prices have been pushed down by the FOMC effect on the short end of the yield curve.

This has resulted in the ETF’s yield climbing 150bps from a year ago, matching the growth in payouts over that time frame. If that continues until rates peak, I would expect the YTM could increase somewhat from here.

Final thoughts

The iShares High-Yield Term series currently has ETFs for each year thru 2030.

The most recent, the iShares iBonds 2030 Term High Yield and Income ETF (IBHJ) was created last June. With CD rates past three years indicating the belief rates are coming down, investor who agree might be best served by going out until at least 2029 to “lock in” the current 8.67% YTM. My personal view is each of these ETFs has an adequate yield premium over a similar term CD to justify giving each a Buy rating at this time.

Recently posted was a more cautious view: IBHF: Waiting For An Entry Into 2026 High Yield Bonds