October 10, 2009 at 1:00 am by Tom Lydon
With the vast array of bond exchange traded funds (ETFs) on the market, not all of them are created equal, and some may risk getting higher returns without properly looking under the hood.
Tom Lauricella of The Wall Street Journal suggests that in general, investors have tended to pay more for bond funds than the portfolios are worth. He dissects the Vanguard Total Bond Market ETF (NYSEArca: BND), which is up 4% year-to-date.
Since its launch in April 2007, the ETF’s daily closing price has been equal to or above the net asset value (NAV) — or the per-share value of its holdings — 98% of the time, and 36% of the time by a meaningful 0.5% or more. Additionally, Lauricella states that the gaps typically have been much wider for municipal-bond and corporate-bond ETFs, especially those holding low-rated “high yield” bonds.
This also highlights the issue of “index drift.” This was recently seen in the SPDR Barclays Capital High Yield (NYSEArca: JNK). It fell nearly 1% in the year ending Aug. 31 as its benchmark rose 6%. One problem was that the ETF couldn’t get some lower-quality bonds held in the index. Bond ETF providers are aware of the challenges in building bond ETFs, and strive to build them so that their ETFs work optimally.
This hasn’t hurt the popularity of bond ETFs, and they’ve gotten more than half of new cash flowing into ETFs, reports Eleanor Laise for The Wall Street Journal.
This could be because the funds are an immensely easy and efficient way to access what can be an expensive market. They offer the kind of diversification that could be cost-prohibitive otherwise.
For more stories on bond ETFs, visit our bond ETF category.
Kevin Grewal contributed to this article.
Tags: BND, Bond ETFs, ETF 101, High-Yield Bonds, HYG, Trend Following
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