With the plethora of investment choices out there, could fixed-income exchange traded funds (ETFs) enable one to maximize a portfolio’s performance?
The vast array of bond ETFs enable investors to grab exposure to international Treasuries, emerging market debt, Treasury Inflated Protected Securities (TIPS), convertibles and mortgage-backed securities. You get the point – just about every aspect of fixed income has been covered by ETFs, giving investors the opportunity to diversify and reap the risk-reward benefits that traditionally come from equities, state Matt Hougan and Dave Nadig of Index Universe.
But…do they work?
- Opponents of bond ETFs suggest that the premium or discount that they trade at from their underlying net asset value (NAV) is what deters them from trading them.
- Advocates suggest that this characteristic is what enables investors to know the true value that one is willing to put on a basket of bonds.
Bond indexes aren’t set up like stock indexes. Bonds tend to trade just a few times each day, and there are some that may go days without trading. For that reason, bond indexes are calculated by using a combination of “actual bond trading prices and best-guess synthetic prices,” received from bond-pricing services.
It’s important to be mindful of the risks in bond ETFs. If the underlying holdings aren’t liquid (such as what happened with the iShares iBoxx High Yield Bond (HYG) ETF at the height of the credit crisis), it could cause the fund to drift from the NAV.