Let’s contrast that with the way that a bond ETF trades:
Unlike individual bonds, bond ETFs trade on an exchange, like the NYSE. The exchange is a centralized trading system that connects buyers and sellers, and prices are quoted continually throughout the trading day. This transparency gives participants a view into how the overall market is valuing an ETF, which in turn can help to narrow spreads and lower transaction costs for investors. If Customers A and B both buy the same bond ETF at the same time, they have largely the same access to inventory and price information, and their execution prices for similar trade sizes are likely to be similar.
For me, this discussion illustrates the core benefits of bond ETFs for most investors. You can see a variety of fixed income markets trading in real-time on the exchange, everything from Treasuries to corporate bonds to emerging market debt. You can observe the bid and offer prices where the funds trade to get a sense of the transaction costs you might incur. And ETFs trade on an exchange, so you don’t need to call your broker to inquire about inventory.
In a nutshell, bond ETFs provide transparency, efficiency and liquidity – attributes that are traditionally hard to come by in the fixed income market. The bond ETF democratizes the bond market, providing all investors with similar market information and access. This lets investors spend more time on their investment strategy, and less time on the phone.
Bonds and bond funds will decrease in value as interest rates rise and are subject to credit risk, which refers to the possibility that the debt issuers may not be able to make principal and interest payments or may have their debt downgraded by ratings agencies. There can be no assurance that an active trading market for shares of an ETF will develop or be maintained. When comparing bonds and ETFs, it should be remembered that management fees associated with fund investments, including ETFs, are not borne by investors in individual bonds.
Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy.