Global fixed income exchange traded fund (ETF) assets have increased to more than $1.6 trillion.1This steady growth has created a more centralized and transparent fixed income marketplace. And Cerulli Associates expects ETF assets to continue to grow as advisors increase their ETF allocations, retail investors become familiar with the vehicle and product suites expand.2
More Than a Decade of Fixed Income ETF Growth
Benefits of Bond ETFs
ETFs’ unique characteristics enable investors to:
Lower CostsUS-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.3
ETFs offer structural advantages, compared to a single security or individual bond exposure. With individual bonds, broker-dealers collect commissions on bonds they sell or buy through markups and markdowns, which are bundled into the quoted price to investors on both sides of the transaction.
When an investor buys a bond, the dealer marks up the price of the bond above its face value. When an investor sells, the dealer will mark down the price of the bond and pay less than its current value. These transaction costs usually range from 1%–5% of the bond’s original value; however, they vary based on order size, issue or broker. Regulations now require bond dealers to publish their markups and markdowns on certain types of bonds on trade confirmations, which means after the transaction occurs.
Improve LiquidityETFs’ robust secondary market allows investors to tap into market liquidity more easily than they can with single-CUSIP bond holdings. 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.
Increase TransparencyBoth index-based and actively managed ETFs report holdings daily, increasing transparency for investors performing daily portfolio due diligence and attribution for risk management.
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.
Target DurationETFs precisely cover the entire term structure along the yield curve, so investors can fine tune a portfolio’s interest rate risk (duration) to match market views or client liabilities.
Modulate Credit RiskRanging from investment-grade credit to crossover debt to senior loans to high yield, ETFs allow investors to control the amount of credit risk in a portfolio with ease and transparency.
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Footnotes
1Morningstar, as of 06/31/2022.
2Cerulli Associates, April 21, 2021.
3Morningstar as of 06/30/2022. Oldest share class of mutual funds used in calculation.
4Morningstar as of 06/30/2022.
5Bloomberg Finance L.P., Morningstar, as of 06/30/2022.
Glossary
Alpha
A gauge of risk-adjusted outperformance that is measured relative to a benchmark because benchmarks are often considered to represent the market’s movement as a whole. The excess returns of a fund relative to the return of a benchmark index is the fund’s alpha.
Bloomberg US Aggregate Bond Index
A benchmark that provides a measure of the performance of the U.S. dollar denominated investment grade bond market. The Agg includes investment-grade government bonds, investment-grade corporate bonds, mortgage pass through securities, commercial mortgage backed securities and asset backed securities that are publicly for sale in the US.
Bond
A debt investment in which an investor loans money to an entity — typically a corporate or governmental entity — that borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. Owners of bonds are debtholders, or creditors, of the issuer.
CUSIP
Stands for the Committee on Uniform Securities Identification Procedures. Formed in 1962, this committee developed a system that identifies securities, specifically U.S. and Canadian registered stocks, US government and municipal bonds, exchange-traded funds and mutual funds.
Duration
A commonly used measure, expressed in years, that measures the sensitivity of the price of a bond or a fixed-income portfolio to changes in interest rates or interest-rate expectations. The greater the duration, the greater the sensitivity to interest rates changes, and vice versa. Specifically, the specific duration figure indicates, on a percentage basis, by how much a portfolio of bonds will rise or fall when interest rates shift by 1 percentage point.
Liquidity
The ability to quickly buy or sell an investment in the market without impacting its price. Trading volume is a primary determinant of liquidity.
Yield
The income produced by an investment, typically calculated as the interest received annually divided by the price of the investment. Yield comes from interest-bearing securities, such as bonds and dividend-paying stocks.
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Originally Posted August 12, 2022 – Why Invest in Bond ETFs
Disclosure
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.
ETF expenses will reduce returns. Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs. In general, ETFs can be expected to move up or down in value with the value of the applicable index. Although ETF shares may be bought and sold on the exchange through any brokerage account, ETF shares are not individually redeemable from the Fund.
Actively managed funds may underperform its benchmarks. An investment in the fund is not appropriate for all investors and is not intended to be a complete investment program. Investing in the fund involves risks, including the risk that investors may receive little or no return on the investment or that investors may lose part or even all of the investment.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
Investing involves risk including the risk of loss of principal.
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Disclosure: ETFs
Any discussion or mention of an ETF is not to be construed as recommendation, promotion or solicitation. All investors should review and consider associated investment risks, charges and expenses of the investment company or fund prior to investing. Before acting on this material, you should consider whether it is suitable for your particular circ*mstances and, as necessary, seek professional advice.
