Amid escalating fears that an interest rate hike from the Federal Reserve could come as soon as the second quarter, investors are rapidly departing from bond ETFs this month. Investors already pulled $6.4 billion from bond ETFs during the first 10 trading days of March, Reuters reports, citing TrimTabs Investment Research.
Still, fixed income ETFs offer advantages. “A significant majority of the actively managed funds in the longer-term government bond and longer-term, investment-grade corporate bond categories underperformed their benchmarks, while these same categories had shown the largest percentage of outperformance over the one-year period that ended in December 2013,” according to S&P Dow Jones Indices’ recent SPIVA scorecard highlighting the ongoing futility of active managers across assets classes. [Another Bad Year for Active Management]
“Actively managed fixed income mutual funds have not performed well relative to widely used Barclays indices. Indeed, in seven of the ten taxable fixed income styles, the average active mutual fund lagged the benchmark. Just 23% of actively managed high yield bond funds outperformed the Barclays High Yield index in the three years ended December 2014.While past performance is not indicative of future results, it is little surprise that the most popular taxable high yield ETFs had more than $2.8 billion of inflows during the last 12 months as many investors have shifted away from actively managed mutual funds,” said S&P Capital IQ in a new research note.
Not surprisingly, passively managed bond ETFs offer a cost advantage over their actively managed mutual fund counterparts. As S&P Capital IQ notes, the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB), the largest emerging markets bond ETF, charges 0.4% per year. The equivalent actively managed mutual funds charge, on average, three times as much. [Mind Global Currency Exposure in ETFs]
The Vanguard Total International Bond ETF (NYSEArca: BNDX) is another example of a cost-efficient international bond ETF. BNDX charges just 0.2% per year, making it less expensive than 81% of rival ETFs. That also makes the ETF less expensive than most actively managed international bond mutual funds. BNDX debuted in 2013 and already has $3.7 billion in assets under management.
“According to Vanguard, foreign currency accounts for two-thirds of the volatility investors experience when buying international bonds. As such, in an effort to isolate the credit and interest rate risk, BNDX employs currency hedging. As the bond index rebalances at the end of each month, Vanguard rolls forward one-month foreign exchange derivatives to offset any moves in the various currencies,” said S&P Capital IQ, which rates BNDX overweight. [An Excellent Year for This Bond ETF]
Intraday liquidity offered by bond ETFs is another advantage compared to one-price-per-day mutual funds.
“Investors have long been aware that mutual fund buy/sell orders are executed at the end of the trading day on which they are entered. However, changes to Federal Reserve policies or other market developments, could warrant a need for more timely execution of trades, even for long-term ETF investors. The yield on the 10-year Treasury bond unexpectedly rose 13 basis points to 2.24% on March 6, for example, but mutual fund investors had to wait to the closing bell to have their trades executed,” notes S&P Capital IQ.
Vanguard Total International Bond ETF