Rough Times Aside, Bond ETFs Still Have Benefits

First, let’s demystify that headline. The point of emphasis in this article isn’t to praise fixed income exchange traded funds from a performance perspective. With the Bloomberg US Aggregate Bond Index down almost 9% in 2022, that would be foolish.

Rather, the point is to highlight some of the non-performance related advantages of bond ETFs that advisors can highlight to clients. In many cases, these perks apply to both active and passive ETFs across a broad assortment of bond market segments.

Importantly, the non-performance perks associated with fixed income ETFs are sticky and aren’t linked to factors such as Federal Reserve interest rate policy, default rates or other issues. With those considerations in mind, here are some notable benefits associated with bond ETFs.

Costs Considerations, Liquidity Matters

The low-cost of reputation of ETFs isn’t confined to stocks. It’s easily found in the fixed income space, too, which is music to the ears of both advisors and cost-conscious clients.

“US-listed fixed income ETFs have a median expense ratio of 0.29%, versus mutual funds’ 0.61%. While many ETFs are index based, this lower-cost profile carries over to actively managed ETFs that have a median expense ratio of 0.40%, versus 0.63% for actively managed bond mutual fund strategies,” according to State Street Global Advisors (SSGA).

In addition to lower costs, end users have come to love the fact that ETFs, both active and passive, update holdings on a daily basis. Conversely, actively managed mutual funds, regardless of asset class, are only required to provide such transparency on a quarterly basis.

“Both index-based and actively managed ETFs report holdings daily, increasing transparency for investors performing daily portfolio due diligence and attribution for risk management,” adds SSGA. “Mutual funds report their holdings less frequently — typically, quarterly. That means any allocation changes in a bond mutual fund could take place months before shareholders are aware of them.”

Then there’s the matter of liquidity. Some corners of the bond market aren’t highly liquid, meaning selecting individual issues in those areas is risky. Fixed income ETFs dramatically improve the liquidity proposition.

“ETFs' robust secondary market allows investors to tap into market liquidity more easily than they can with single-CUSIP bond holdings,” notes SSGA. “This enables them to reallocate portfolios quickly across asset classes or meet investor redemptions by selling an ETF position into the market without having to sell single-CUSIP bonds. Fixed income ETFs are also more liquid than mutual funds, as ETFs trade intraday and mutual funds are typically transacted end of day.”

Active Considerations

Many advisors grew up in the business on active bond funds. Fortunately, ETFs answer that bell, too.

For all the criticism active management endured in recent years, today’s fixed income climate is highly conducive to fixed income investors considering active mutual funds and exchange traded funds.

For novice investors, evaluating active management could be pivotal in a treacherous fixed income environment on the basis that an index-based strategy will only deliver the index’s returns minus fund fees while active managers seek returns in excess of a particular benchmark.

“Using the vast array of ETFs to optimize portfolios for precise yield, duration, spread, and sector, or even to naively reweight sectors of the Bloomberg Barclays U.S. Aggregate Index, investors can create custom portfolios across a wide array of bond subsectors,” concludes SSGA. “More than 197 actively managed bond ETFs have launched in the US over the past 10 years and now have more than $117 billion of AUM. Some of these ETFs have 3-, 5- or 10-year track records.”

Related: An Angelic Idea for Second-Half Bond Allocations