Investors are always on the lookout for novel ways to diversify their holdings and limit their exposure to risk. One popular option that has gained popularity in recent years is the bond ETF. In this blog post, we’ll explain what bond ETFs are and why they might be a good complement to any financial portfolio.
How are bond ETFs operated?
Bond ETFs, also known as exchange-traded funds, are investment vehicles that trade on stock exchanges similarly to regular equities. Bond ETFs, on the other hand, track the performance of a certain bond market index or sector and consist of a portfolio of bonds rather than stocks. This category may include corporate, municipal, government, or a combination of these bonds.
Bond ETFs are similar to mutual funds in that they combine client assets to purchase a wide range of bonds.
How do bond ETFs function?
Bond ETFs are designed to replicate the historical performance of a specific bond market index, such as the Bloomberg Barclays U.S. Aggregate Bond Index. The share price of the ETF will fluctuate throughout the day according to the market value of the underlying bonds.
Also read: Active vs. Passive ETF Investing: What’s the Difference?
Bond ETFs are created in a way that allows them to pay investors dividends in the form of interest income.
Also read: What Is a Bond ETF? Definition, Types, Examples, and How to Invest
What benefits do bond ETFs provide?
Bond ETFs offer investors a number of benefits, including:
Bond ETFs provide investors with exposure to a variety of bonds, which can help reduce the overall risk of the portfolio.
Due to their improved liquidity, bond ETFs are more tradable than traditional mutual funds throughout the day.
Bond ETFs offer liquidity. Individual bonds, which may have limited liquidity in the secondary market, are often less liquid than bond ETFs, which trade on exchanges. Investors will find it easier to buy or sell bond ETF shares as needed as a result.
Bond ETFs may offer improved tax efficiency compared to individual bonds or actively managed bond funds.
Individual bond purchases and sales can be expensive; transaction expenses include broker fees, bid-ask spreads, and taxes. Bond ETFs can save investors money by allowing them to trade a wide portfolio of bonds in a single transaction.
More investors can access bond ETFs because they usually have lower minimum investment requirements.
Bond ETFs can boost transparency by enabling investors to view the bonds they possess and their matching weightings thanks to the daily release of their holdings. Because of this transparency, investors might be better able to understand the risk and return characteristics of the ETF.
Also read Ray Dalio’s All-Weather Portfolio Review, ETFs, and Leverage (2024).
Investors can reduce the risk involved in making investments in certain bonds or in just one region of the bond market by diversifying their holdings.
Below are some of the largest bond ETFs by assets under management as of 2024. It can change frequently.
Also visit: Bond ETF List
BND: This popular ETF offers exposure to the entire investment-grade bond market in a single ticker, with holdings in T-Bills, corporates, MBS, and agency bonds.
AGG: This ETF offers broad-based exposure to investment-grade U.S. bonds, making AGG a building block for any investor constructing a balanced long-term portfolio as well as a potentially attractive safe haven for investors pulling money out of equity markets.
BNDX tracks an investment-grade, non-USD-denominated bond index hedged against currency fluctuations for US investors. BNDX offers broad market-like exposure to investment-grade bonds denominated in foreign currencies, hedged against currency fluctuations, for US investors.
TLT: This ETF is one of the most popular options for investors seeking to establish exposure to long-dated Treasury securities, an asset class that is light on credit risk but may offer attractive yields thanks to an extended duration and therefore material interest rate risk.
VCIT: VCIT offers exposure to investment-grade corporate bonds that fall in the middle of the maturity spectrum, thereby delivering a moderate amount of both interest rate and credit risk.
MUB: This fund tracks an index of municipal bonds, a slice of the bond market that is highly coveted due to its tax features.
VCSH: VCSH offers exposure to investment-grade corporate bonds that fall towards the short end of the maturity spectrum, thereby delivering a moderate amount of credit risk while limiting exposure to rising interest rates.
LQD: This ETF is the most popular option for investors looking to gain exposure to investment-grade corporate bonds, making it a useful tool for those looking to access a corner of the bond market that should be a core component of any long-term, buy-and-hold portfolio.
HYG: HYG tracks a market-weighted index of US high-yield corporate debt. HYG was the first mover in the high-yield corporate bond market. For many years, it’s been one of the largest and most liquid junk bond ETFs, along with archrival JNK.
PFF: PFF tracks an index of preferred stocks traded on the NYSE and NASDAQ. Market value and rule-based, proprietary methods are both used to select securities. PFF targets preferred securities irrespective of credit rating, providing a broad and diversified portfolio. The fund’s holdings reflect the nature of the market in that financial institutions dominate the holdings.
FPE: FPE is an actively managed fund that attempts to generate income by investing globally in preferred equities and income-producing debt across the market cap spectrum.
CWB: CWB tracks a market-cap-weighted index of US convertible securities of any credit quality. CWB represents the US convertible securities space with a market-value-weighted and market-value-selected portfolio.
ANGL: ANGL tracks a market-value-weighted index of bonds that were rated investment grade at issuance but later downgraded to sub-investment grade.
Treasury ETFs, or Treasury Exchange-Traded Funds, are investment funds that primarily invest in U.S. Treasury securities. These ETFs offer investors exposure to a diversified portfolio of Treasury bonds with various maturities, such as short-term Treasury bills, intermediate-term Treasury notes, and long-term Treasury bonds.
Below are largest Treasury ETFs
BIL: BIL tracks a market-weighted index of all publicly issued zero-coupon US Treasury bills with a maturity of at least 1 month, but less than 3 months. his popular ETF offers exposure to the ultrashort end of the maturity curve, focusing on zero coupon U.S. T-Bills with less than three months until maturity. BIL is extremely light on both interest rate risk and credit risk, and as such will generally deliver a very low expected return.
SGOV: SGOV tracks a market-value weighted index of US Treasurys maturing in less than or equal to three months. SGOV offers vanilla exposure to ultra-short-maturing fixed income securities of the US Treasury market. The fund is tracking the ICE 0-3 Month US Treasury Securities Index whose components are selected and weighted by market value, and rebalances every month.
USFR: USFR tracks a market-value-weighted index of US Treasury floating-rate securitiesUSFR launched just weeks after the first floating-rate Treasurys (or FRNs) came to market in early 2014. The fund selects FRNs that have a two-year term that have an issue date on or before the index rebalancing date.
Also read: inflation-protected bond ETFs.
iBonds: A Safe and Smart Investment Option
Inflation is a constant concern for investors, as it can erode the purchasing power of their savings. One way to protect against inflation is by investing in iBonds, a type of savings bond offered by the US Treasury Department. In this blog, we will discuss what iBonds are, how they work, and their advantages as a safe and smart investment option.
Also visit: Bond ETF Finder
It’s crucial to remember that bond ETFs do involve some risks. The value of a bond ETF can change depending on a number of variables, including changes in interest rates, credit risk, and economic conditions, much like the value of any investment. Bond ETFs that invest in emerging markets or high-yield bonds may also be riskier than those that invest in investment-grade bonds.
Also read: Historical Returns of Different Stock and Bond Portfolio Weightings
Also, investors need to be aware that bond ETFs may not offer as stable an income stream as individual bonds. While bond ETFs normally distribute dividends on a regular basis, their income may vary depending on changes in interest rates or other market factors.
In conclusion, using bond ETFs is a well-liked and practical approach to investing in the bond market. They give investors liquidity, cost efficiency, and diversification, but they also come with some hazards that investors need to be aware of. When investing in a bond ETF, as with any investment, it’s crucial to carefully consider your financial objectives and risk tolerance.