Why ETFs Are Better for Bonds

Broadly speaking, bonds are mixed bag through the first six months and change of 2024. Using the most widely observed indexes for the following corners of the bond market, domestic junk bonds and dollar-denominated emerging markets debt are higher on the year while aggregate bond strategies, investment-grade corporates and municipal bonds are lower.

That is to say it’s understandable that advisors may not know where to turn in the fixed income space. Same goes for ordinary investors. With mega-cap growth stocks powering broader equity benchmarks to record highs on an almost daily basis, retail investors can be forgiven if they’re ignoring bonds, which are significantly less glamorous than anything related to artificial intelligence (AI).

On the other hand, advisors know that bonds cannot be ignored. Certainly not for too long. The asset class is too large and not all clients should be 100% allocated to stocks. What advisors can do here and now, regardless of how bonds are performing, is consider the best fund vehicle with which to access fixed income instruments: exchange traded funds or mutual funds.

Betting on Bonds with ETFs

ETFs were born out of exposure to equities, but as State Street Global Advisors (SSGA) notes, fixed income ETFs today have $1.58 trillion in combined assets under management. That’s staggering 33% annualized growth in 22 years.

Nice superficial statistic, but here’s where things get interesting. ETFs are the more cost-efficient avenue for accessing and that includes actively managed fixed income ETFs.

“Fees for bond ETFs are 54% lower than their mutual fund peers. Bond ETFs’ median net expense ratio is just 0.29% versus 0.63% for mutual funds,” according to SSGA. “Active fixed income ETFs’ median net expense ratio is 0.40% versus 0.65% for active mutual fund peers.”

As advisors know, bonds are long-term commitments. That means the above fee differentials are all the more relevant to clients because, over time, they’ll save substantial sums by accessing bonds via ETFs over mutual funds.

Choices, Total Costs Matter

ETF issuers are nothing if not inventive and that’s seen in the fixed income space. While not all bond ETFs have staying power nor do they all merit consideration for client portfolios, the point is ETFs have democratized access to previously complex and opaque but potentially rewarding corners of the bond market.

Additionally, when it comes to liquidity, ETFs are vastly superior to mutual funds and that holds true across essentially all asset classes, including bonds. That means ETFs reduce total cost of ownership.

“ETFs’ two trading markets provide increased liquidity to support quick reallocation of portfolios or the ability to meet investor redemptions,” concludes SSGA. “ETFs are tax efficient because they tend to distribute fewer capital gains than mutual funds. In 2023, 31% of equity and fixed income mutual funds distributed capital gains compared to just 2% of ETFs.”

Related: Why ETF Liquidity Matters in Turbulent Market Environments