By Todd Rosenbluth, CFRA
While CFRA incorporates expense ratios in our equity and bond ETF rankings, with lower-cost offerings scoring higher than more expensive ones, this is just one factor in our analysis. In particular, we think investors need to pay attention to the bid/ask spread as trading costs can similarly eat into returns.
iShares Core US Aggregate Bond ETF (AGG) is the largest US listed bond ETF with $49 billion in assets. AGG also has one of the strongest cost factor ranking inputs, aided by its low 0.05% net expense ratios and $0.01 bid/ask spread. However there are other ETFs tracking the prominent investment-grade Bloomberg Barclays Aggregate Index with both lower and higher expense ratios and trading-related costs.
At quick glance, an investor could see that the $4 billion Schwab US Aggregate Bond ETF (SCHZ) has a lower 0.04% expense ratio, while the $1.1 billion SPDR Bloomberg Barclays Aggregate Bond ETF (BNDS) has a higher 0.08% expense ratio. Yet, CFRA thinks the higher $0.02 and $0.05 trading costs for SCHZ and BNDS, respectively, is notable particularly if an investor plans to use the ETF to periodically tactically tilt asset allocations. A fourth bond ETF, Vanguard Total Bond Market Index (BND) tracking a float adjusted Bloomberg Barclays Aggregate Index that excludes bonds held in Federal Reserve accounts, has a 0.05% expense ratio and a $0.01 bid/ask spread.
The above is a rare case where there are multiple ETFs tracking the same benchmark, but most ETFs seek to track a unique index and in some cases the indices can shift. To us, this makes an assessment of an ETF’s index tracking ability less meaningful.
Related: Bond ETF Segment Has More Room to Grow
For example, last week, Vanguard announced planned changes to the target benchmarks of three of its government bond funds to Treasury based indices. Vanguard’s Head of ETF Product Management Rich Powers told CFRA that with greater liquidity in the Treasury market, the bid/ask spreads of the ETF shares could be cut in half. In addition, Vanguard expects no changes to the funds’ expense ratios when the benchmark transitions are fully implemented in the fourth quarter of 2017.
CFRA believes such efforts can be meaningful, as Vanguard Intermediate-Term Government Bond Fund Index (VGIT) and Vanguard Long-Term Government Bond Index Fund (VGLT), two of the impacted ETFs, have $0.05 bid/ask spreads and 0.07% expense ratios; a third ETF, Vanguard Short-Term Government Bond Index Fund (VGSH 61 Overweight) has a $0.01 bid/ask spread and a similar 0.07% expense ratio.
In general, with many bond ETFs year-to-date total returns in the low single-digits, additional costs can meaningfully eat into a fund’s returns. When sorting through the growing bond ETF universe, investors need to look at all the drivers of their ETFs, not just the expense ratio.