In a laddered portfolio, maturing bonds and coupon payments are typically reinvested in bonds at the ladder’s longest rung, which usually offers higher yields. This can be an advantage in a rising interest rate environment.

What is a bond ladder?

A ladder is a portfolio of bonds that mature at regular intervals (often every six months or every year) across a chosen maturity range. As a bond matures, principal is typically reinvested in the rung of the ladder with the longest maturity. This approach seeks to generate a predictable income stream; it may also provide an advantage in a rising rate environment, since periodically maturing proceeds are reinvested at higher yields if market rates rise. Additionally, laddered portfolios composed of municipal bonds can be an attractive investment for investors seeking relatively stable tax-efficient income and capital preservation.

Why consider ladders in the current lower yielding environment?

In the current low yield environment, investors may be understandably concerned about how their municipal investments will perform if rates rise, and whether they will be positioned to take advantage of rising rates. Fortunately, ladders may help ease these concerns: mitigating downside by investing based on a hold-to-maturity philosophy and capturing some of the potential upside by consistently reinvesting into the longest rung of the ladder.

Consider that as bonds “roll down” the ladder over time, a two-year bond will become a one-year bond, a three-year bond will become a two-year bond, etc. As time passes, each rung will typically be filled except for the longest maturity, where reinvestment will be focused as shown in Figure 1. Therefore, over time the portfolio’s average purchase yield* should converge toward the yield of the longest maturity bond in the laddered portfolio – this the tax-efficient income stream increase over time even if market yields remain constant.

*The average purchase yield of a portfolio is the weighted average yield to maturity of the securities in the portfolio at the time of investment.

\Why put money to work now when interest rates may rise further?

There is an opportunity cost to sitting in zero-yielding cash. And, forecasting interest rate movements is difficult even for the most skilled fixed income investor. By investing across a range (or ladder) of maturities, laddered portfolios reduce the need to perfectly “time” interest rates. The longer rungs of the ladder bring the average yield of the portfolio higher and mitigate against the possibility that we remain in a low yield environment for longer than anticipated. Meanwhile, holding shorter maturity bonds helps ensure that if and when rates do rise further, there are opportunities to capture higher yields without having to liquidate existing holdings at a loss.

Why hire an active manager like PIMCO to build a bond ladder?

The municipal market has over 50,000 issuers, and the decline of bond insurance has made independent credit analysis essential. Rigorous fundamental credit research drives the municipal bond selection process for our ladder strategies, and our analysts develop their own internal ratings independent of the rating agencies. We monitor the quality of every credit we purchase on an ongoing and forward-looking basis, helping guard portfolios from the adverse price and liquidity impacts of a negative credit event.

Additionally, because PIMCO manages over $76 billion in municipal assets (AUM as of December 31, 2021), we may be able to provide economies of scale in price and transaction costs that are passed on to investors. As the chart below shows, the average transaction cost for trades less than $10,000 was 0.90%, whereas institutional sized trade costs are considerably less.& As such, buying in larger blocks before allocating across individual accounts can reduce transaction costs for individuals, leading to better execution and the potential for higher yields.

To learn more about investing in municipals at PIMCO, please visit pimco.com/munis