As the head of fixed income strategy for the largest ETF provider in the world, I sometimes take for granted the fact that bond ETFs are still something of a mystery to many savvy investors.
This is partially due to the fact that these funds are still relatively new: iShares launched the first bond ETF only 11 years ago, about 75 years after the first mutual fund was launched. And although fixed income ETFs have come a very long way in a very short time, it’s understandable that the investing public is still getting to know them.
In order to fully appreciate the benefits that bond ETFs can offer, it’s important to first understand how they work. This post is the first in a “master class” series designed to help investors do just that, by covering everything from the basics to the more advanced topics.
First things first – here are three key elements that every investor should know about bond ETFs:
1. A bond ETF typically tracks an index. While there are a few actively-managed fixed income ETFs, for our purposes we’ll focus on index-based products, which generally seek to track the performance of an index minus fees and expenses, and make up the majority of bond ETFs out there.
Like equity indexes, bond indexes typically target a specific part of the market – such as a specific sector (e.g. Treasuries, corporates), credit rating (e.g. Aaa – A), or maturity range (e.g. 7-10 years). Bond indexes combine these elements in a variety of ways, allowing investors to access both broad and narrow segments of the bond market through the ETFs that track them. For example, you can access the total investment grade bond market through a fund like the iShares Core Total US Bond Market ETF (AGG), or specifically target investment grade industrial bonds through a fund like the iShares Industrials Bond ETF (ENGN).
Bottom line: Understanding the underlying index is key to knowing what you own in a bond ETF.
2. A bond ETF’s current price is visible and updated throughout the day on an exchange. While some investors appreciate the fact that they can trade an ETF intraday, others may never take advantage of this feature. And that’s okay, because the mere fact that bond ETFs trade on the stock exchange is still a benefit for those investors, because it provides price transparency in an otherwise opaque market.