Credit risk, or an issuer’s ability to repay debt obligations, is also a major factor to consider. While high-yield, speculative-grade, junk bonds provide attractive income generation, these securities come with a greater potential for defaults where the investor could lose their principle. Bond funds, though, help mitigate some default risk through holding hundreds or thousands of different debt securities. [Emerging Market Bond ETFs: Rising Credit Risk]
ETFs are only as liquid as their underlying assets, but the bond market is far less liquid that the equities market. During times of distress, corporate debt, especially junk bonds, can be difficult to unload.
Inflation can also eat away at bond investment returns. As consumer prices or inflation rises, purchasing power declines and the so-called real value of fixed-income returns also diminish. Investors can calculate their real yield by subtracting inflation from a bond’s current yield. If inflation outpaces the current yield on a debt security, the investor essentially receives a negative real yield. [Fight Back Against Inflation with TIPS ETFs]
For more information on the fixed-income market, visit our bond ETFs category.
Max Chen contributed to this article.