After a volatile year, many investors have jumped out of the equities markets and either held onto their cash or piled into the safer bond market. Investors who want to take on bonds exposure may consider augmenting their investment portfolios with bond exchange traded funds.
What are bond ETFs? Bond ETFs are exchange traded funds that follow the performance of a basket of bonds securities with varying maturity dates, coupon rates and credit rankings. Investors may select ETF products based on a specific sub-set, such as Treasuries, municipal bonds or corporate bonds. Some providers have started to issue international bonds for the globally oriented investor. Additionally, there are total bond funds that capture a range of public and private sector issuance. [ETF Spotlight: Investment Grade Corporate Debt]
Bond ETF benefits? With ETFs, investors are able gain exposure to the bond market during anytime of the trading day. The bond ETFs are highly liquid and fund providers disclose full transparency into holdings. The ETF product helps democratize the bond asset for the average retail investor, since the availability and transparency of bonds have historically been limited to large institutional investors. Additionally, bond ETFs also generate yields for those focused on the fixed-income aspect. [Muni Bond ETFs on a Roll as Yields Hit Record Lows]
Are Bond ETFs risky? Like most investments, greater potential returns come with greater risk. Investors may determine the level of risk they may be comfortable with by looking at the credit worthiness of the debt securities. For instance, the highest credit ratings are those in the A to AAA range. Medium grade refers to those around the BBB/Baa range. These are usually considered investment grade credit ratings. Those labeled non-investment grade or “junk bonds” have ratings of Ba1/BB+ or lower. [Are High-Yield ETFs Also High Risk?]
Potential disadvantages? Bond ETF investors will have to be mindful of the current yield environment. Currently, Treasury bonds are hovering around historic yields after the Fed pledged to keep rates close to near-zero. Additionally, future inflation will also be a major factor, as higher inflation would eat away at returns, and the resulting higher interest rates to combat inflation would also drag on a bond ETF’s performance.