Bond ETFs?

[FrugalLady]

I will be rolling my 401K into an IRA soon, and I am planning on utilizing ETFs instead of mutual funds. I have some ideas for stock ETFs, but I would love to hear suggestions for Bond ETFs.

My asset allocation will be 30% to one or more bond ETFs. I am willing to take a little more risk with a portion of my bond portfolio to get a little higher return, but I am open to any and all suggestions.

 

[BeachOrCity]

Be careful. Bond etf does not behave the same way as a stock etf does.

If Interest rates rise and they have to handle redemption and buy new bonds the yields and assets in the fund will differ from the market as a whole.

If you can’t buy individual bonds some folks on the forum know of etf that you can buy and use more like a ladder because everything in the etf matured at the same time

 

[OldShooter]

Be a little careful here; an EFT is a mutual fund. The similarities between conventional and exchange-traded funds are much more than the differences. And, as @BeachOrCity points out, the values of bond funds vary as interest rates change. Be sure you understand how "duration" works when buying funds The punch line is that in a rising interest rate environment it is much easier to lose money in bond funds than it is when buying individual bonds.

My experience is at Schwab and the bond desk guys there are both knowledgeable and helpful. Fido and others are probably similar. If you are looking at govvies or high grade corporates you should really consider just building a bond ladder with individual bonds. The bond desk guys can help and it isn't hard.

If you are looking at more exotic stuff like junk bonds and emerging market bonds, then a professional manager's fees are probably worth paying. Buy why?? If you want a little more risk, a little more volatility, and a little more yield in your portfolio, why not just leave a little bit more money in equities?

 

[pb4uski]

The concern of many people, including me, is interest rate risk. In theory, if you hold a bond fund for longer than its duration then you recover any price declines as a result of increases in interest rates.

I use target maturity bond ETFs to mitigate interest rate risk. Guggenheim and Blackrock offer them... Guggenheim Bulletshares and Blackrock iBonds. They are like owning a share in a diversified portfolio of bonds that all mature in a particular year.

 

[Sunset]

That would be the family of Guggenheim BulletShrs bond etf's

For example BSJM (not saying this is the best one, but I bought some).

Read about them on the Guggenheim website to see how they work. Basically my understanding is they are a collection of bonds that mature around the same time. After they mature, you get your $$ back (minus any failed bonds). They pay the interest monthly as it is earned.

 

[OldShooter]

The concern of many people, including me, is interest rate risk. In theory, if you hold a bond fund for longer than its duration then you recover any price declines as a result of increases in interest rates.

I use target maturity bond ETFs to mitigate interest rate risk. Guggenheim and Blackrock offer them... Guggenheim Bulletshares and Blackrock iBonds. They are like owning a share in a diversified portfolio of bonds that all mature in a particular year.

Let me be devil's advocate here:

What you are essentially doing is simulating the buying of individual bonds for a ladder. The positive of this approach is more diversification. The negatives are spreads, commissions (if any), and management fees.

Assuming your funds are buying fairly high-grade stuff and govvies, and assuming that you are not investing just a small amount of money, I would think that you could get adequate diversification on your own. (Probably not true for international, emerging market, or junk, though.)

Is this how you think about it or am I missing something?

 

[FrugalLady]

I would be investing $80000 in bonds. Is that enough for a bond ladder or bond ETF ladder? I am aware that a bond ETF will react the same as a bond mutual fund in a rising rate environment. Also, FYI, I will not be needing to tap this money for 10 years.

 

[brewer12345]

Let me be devil's advocate here:

What you are essentially doing is simulating the buying of individual bonds for a ladder. The positive of this approach is more diversification. The negatives are spreads, commissions (if any), and management fees.

Assuming your funds are buying fairly high-grade stuff and govvies, and assuming that you are not investing just a small amount of money, I would think that you could get adequate diversification on your own. (Probably not true for international, emerging market, or junk, though.)

Is this how you think about it or am I missing something?

Given the availability of the bullet maturity ETFs, individual investors have no business buying individual bonds, especially corporates. The bid-ask spreads mean you get skinned and most retail investors cannot or will not do an adequate job of analyzing and monitoring the credit of a portfolio of issuers sufficiently large to diversify your risk.

As for OP, this is a lousy time to take risk in the bond market as you are not really well compensated for it. Stick to modest durations, investment grade credit, and avoid mortgage-backed bonds.

 

[pb4uski]

Let me be devil's advocate here:

What you are essentially doing is simulating the buying of individual bonds for a ladder. The positive of this approach is more diversification. The negatives are spreads, commissions (if any), and management fees.

Assuming your funds are buying fairly high-grade stuff and govvies, and assuming that you are not investing just a small amount of money, I would think that you could get adequate diversification on your own. (Probably not true for international, emerging market, or junk, though.)

Is this how you think about it or am I missing something?

You make some valid points that I have thought about. The ERs for Guggenheim and Blackrock are 24 bps and 10 bps, respectively, so while I am paying what I consider to be modest fees, on the other hand, I suspect that Guggenheim and Blackrock are getting better pricing on the underlying bonds that they purchase for the fund than I would get buying individual bonds as a retail investor with Vanguard or Fidelity so there is a bit of an offset there I think. The other aspect is convenience, someone else who is knowledgable about the bond market is selecting the issues so I don't have to or deal with a bond desk that gives me a menu of bonds to chose from.

I don't pay commissions but do sometimes buy at a premium to NAV, though sometimes at a discount, but I figure that into the yield in deciding whether to buy.

And as you point out, on the high-yield side management is often worth the cost and it is an extra 16 bps (the high yield ER is 40 bps).

I've had these a number of years now and have been pretty pleased with their performance.

There is one nuance to keep in mind though... in the terminal year as bonds mature they invest the proceeds in commercial paper until they do a year-end terminal distribution so the terminal year distributions are pathetic since they are a mix of bond yields and commercial paper yields... but my solution is to just sell about a year before the terminal distribution... since these are principally a retail product that is thinly traded the pathetic terminal year return doesn't seem to be priced into the market.

 

[pb4uski]

I would be investing $80000 in bonds. Is that enough for a bond ladder or bond ETF ladder? I am aware that a bond ETF will react the same as a bond mutual fund in a rising rate environment. Also, FYI, I will not be needing to tap this money for 10 years.

Check out https://www.guggenheiminvestments.com/etf/resources/etf-bond-ladder. If you put $10k in each of the 2019-2026 you would get roughly 2.5% interest with a duration of 4.5 years. Another alternative would to just buy a 5 year CD or a CD ladder.... pretty close to the same return with simplicity.

Yield to Maturity	2.75%
Yield to Worst	2.74%
30-Day SEC Yield	2.46%
Distribution Rate	2.46%
Effective Duration	4.50 yrs
Holdings (#)	2289
Portfolio Range	2019 - 2026

 

[OldShooter]

I would be investing $80000 in bonds. Is that enough for a bond ladder or bond ETF ladder? I am aware that a bond ETF will react the same as a bond mutual fund in a rising rate environment. Also, FYI, I will not be needing to tap this money for 10 years.

$80K is probably not enough to be diversified if buying corporates. But the point of diversification is to reduce risk, so if you buy government and agency bonds backed by the full faith and credit of the US there is no risk and hence no need to worry about diversification.

Others here are more sophisticated and experienced with all the bond options and will weigh in, but for me I like TIPS. The yield on paper doesn't look too great but you are more than fully protected against inflation. By "more" I mean that if we get a shot of inflation the TIPS will probably rise in value as demand rises and if it gets really exciting Treasury will stop issuing them thus goosing their value even higher.

If you want to buy corporates and if after fees the yield is attractive then your original plan of bond funds is probably the right one and pb4uski's suggestion would look pretty attractive to me.

 

[Freedom56]

I will be rolling my 401K into an IRA soon, and I am planning on utilizing ETFs instead of mutual funds. I have some ideas for stock ETFs, but I would love to hear suggestions for Bond ETFs.

My asset allocation will be 30% to one or more bond ETFs. I am willing to take a little more risk with a portion of my bond portfolio to get a little higher return, but I am open to any and all suggestions.

Beware of both bond funds, preferred stock funds, bond ETFs, and preferred stock ETFs. You can suffer a loss of capital when rates rise and the fund managers are forced to sell securities at a loss to raise cash for redemptions. In addition you are paying a management fee. Whereas if you hold your own portfolio of individual bonds and preferred stocks, you have the flexibility of holding the issue to maturity or when called for a return of your capital. These funds and ETFs do not manage interest rate risk well. But on the other hand they do create opportunities for investors to buy their holdings cheap when they are forced to liquidate. Any financial adviser that tells you otherwise, doesn't understand the fixed income market. They will argue that they offer more diversification. That's true except that the diversification they offer is the funds weakness. Most of these bond ETFs and funds are passively managed which means that they hold issues until they are called, forced sell due to redemptions, or in a lot of cases in default. Think of all the debt in the retail and energy sector that these funds are holding. These funds didn't even see the ToysRus default coming. Is this the kind of diversification you really want? Think of how much debt from Sears and JC Penny that these funds are holding. Do you really want that kind of diversification?

 

[JohnnyBGoode]

Check out https://www.guggenheiminvestments.com/etf/resources/etf-bond-ladder. If you put $10k in each of the 2019-2026 you would get roughly 2.5% interest with a duration of 4.5 years. Another alternative would to just buy a 5 year CD or a CD ladder.... pretty close to the same return with simplicity.

Yield to Maturity	2.75%
Yield to Worst	2.74%
30-Day SEC Yield	2.46%
Distribution Rate	2.46%
Effective Duration	4.50 yrs
Holdings (#)	2289
Portfolio Range	2019 - 2026

Interesting point about the CD's as a good alternative to bonds at this point. I've had the same thought myself. Rising interest rates seem inevitable so bonds don't look so hot right now. Given some competition in the CD area that seems like a really good alternative. Plus I know Ally has the "no-risk" CD at 1.5% that you can jump out of at any time (after the first 6 days).

 

[foxfirev5]

I've got about half my fixed income in a 5 year CD ladder. If rates go up so will my income as I roll the shorter term CDs into 5 year. (Unless the yield curve flattens or inverts). If rates go down my bond funds will at least temporarily go up in NAV.
There's not much else I can do but take what the market gives me.

 

[LOL!]

Beware of both bond funds, preferred stock funds, bond ETFs, and preferred stock ETFs. You can suffer a loss of capital ...

Of course bond funds are risky. We all know that. Sometimes bond funds lose money, but so what? Sometimes stock funds lose money, too.

As for the OP, I own bond funds and bond ETFs. They produce the same long-term return for the same kind of index fund. For example, an intermediate-term or total bond index fund like FSITX or AGG would be entirely equivalent even though dividends are paid out differently.

Over the long-term, bonds should do better than cash and a bond fund or ETF is an easy way to own bonds.

 

[OldShooter]

Of course bond funds are risky. We all know that. Sometimes bond funds lose money, but so what? Sometimes stock funds lose money, too.

I really don't see the point here. Sometimes gold investments lose money. Sometimes real estate investments lose money. But the OP is not asking about gold, real estate, or stocks.

As for the OP, I own bond funds and bond ETFs. They produce the same long-term return for the same kind of index fund. For example, an intermediate-term or total bond index fund like FSITX or AGG would be entirely equivalent even though dividends are paid out differently.

Yes. Similar funds have similar yields and there is little difference between conventional mutual funds and exchange-traded mutual funds. Ho-hum.

Over the long-term, bonds should do better than cash and a bond fund or ETF is an easy way to own bonds.

All true, but even with the last sentence the post has not addressed @Freedom56's point: An investor (especially in a rising interest rate environment, I'll add) is much more likely to lose money in a bond fund than he/she is buying individual bonds and holding them to maturity. If they are govvies, the investor has essentially a zero chance of losing money.

I can certainly agree with the last few words: "... a bond fund or ETF is an easy way to own bonds." But IMO the thought is incomplete. I would complete it this way: "... a bond fund or ETF is an easy way to own bonds at the cost of increased risk and of paying management fees."

Now the OP said that she had only $80K to put into bonds. If she wants to do anything besides govvies and agencies, then I think she has little choice but to buy a fund simply because $80K is not enough to adequately diversify. But if she wants govvies and agencies and is willing to forego the "easy way" in favor of the more profitable way, then buying individual bonds is clearly the better choice.

 

[Freedom56]

Of course bond funds are risky. We all know that. Sometimes bond funds lose money, but so what? Sometimes stock funds lose money, too.

As for the OP, I own bond funds and bond ETFs. They produce the same long-term return for the same kind of index fund. For example, an intermediate-term or total bond index fund like FSITX or AGG would be entirely equivalent even though dividends are paid out differently.

Over the long-term, bonds should do better than cash and a bond fund or ETF is an easy way to own bonds.

The point I was trying to make was that when you own individual bonds, your returned principal and coupon rate to maturity or call date is known at the time you make the purchase. You do not have that guarantee with bond ETFs and bond funds. For example I purchased a GE note back in 2008 (rated AA- now) yielding 5.2% at par. It pays semi-annually and matures February 2018. I will get 100% of my principal back this coming February plus my last coupon payment. Even if the 10 year note went up to 11%, I would still get 100% of my principal returned at maturity plus my coupon payment. A bond fund or ETF cannot make the same guarantee.

 

[OldShooter]

... A bond fund or ETF cannot make the same guarantee.

Exactly!

 

[alaska55]

sorry a corp bond can't guarantee either.

 

[pn3069]

FrugalLady - Several choices exist for bond ETFs. I will list them below.

1. Stick with an index bond ETF -- Investment Grade Aggregate US Bond ETFs -- BND or AGG for example, and/or Investment Grade International Bond ETFs -- BNDX.


2. Buy some active bond ETFs - like BOND and GTO which still focus on investment grade bonds.

3. Venture into Multi-Sector Bonds where you buy a basket of bond ETFs that focus on different sectors.

4. (not an ETF) but a mutual fund PIMIX [PIMCO Income fund] is available in most brokerage houses for $25,000 minimum investment. It is perhaps the best managed active bond fund since its inception.

Let me know if any of these options interest you and I can share more details.

 

[pn3069]

The point I was trying to make was that when you own individual bonds, your returned principal and coupon rate to maturity or call date is known at the time you make the purchase. You do not have that guarantee with bond ETFs and bond funds. For example I purchased a GE note back in 2008 (rated AA- now) yielding 5.2% at par. It pays semi-annually and matures February 2018. I will get 100% of my principal back this coming February plus my last coupon payment. Even if the 10 year note went up to 11%, I would still get 100% of my principal returned at maturity plus my coupon payment. A bond fund or ETF cannot make the same guarantee.

There is value in diversification that you will not get with individual bonds...

...bond funds will yield more as rates rise over time but the individual bonds will not yield more.

 

[OldShooter]

... bond funds will yield more as rates rise over time but the individual bonds will not yield more.

Please explain that in terms of total return, fund duration, etc. If you simply mean that the bond fund yield % will increase when the fund value gets whacked by rising rates that's just arithmetic; it certainly cannot make a total return calculation attractive. If you mean that somehow total return vs an individual bond goes up for a fund investor in a rising rate environment I would like to see that calculation. It sounds like a free lunch to me.

 

[pb4uski]

sorry a corp bond can't guarantee either.

You're referring to credit/default risk.... they were referring to interest rate risk (change in value due to changes in interest rates).... all else being equal the credit risk of a diversified
individual bond portfolio and a bond fund are the same.

 

[GravitySucks]

The concern of many people, including me, is interest rate risk. In theory, if you hold a bond fund for longer than its duration then you recover any price declines as a result of increases in interest rates.

I use target maturity bond ETFs to mitigate interest rate risk. Guggenheim and Blackrock offer them... Guggenheim Bulletshares and Blackrock iBonds. They are like owning a share in a diversified portfolio of bonds that all mature in a particular year.

I also use BlackRock iBonds for my bond ladder.
Also use the ETF AGG for a general type bond fund.

 

[OldShooter]

You're referring to credit/default risk.... they were referring to interest rate risk (change in value due to changes in interest rates).... all else being equal the credit risk of a diversified
individual bond portfolio and a bond fund are the same.

Yes, thanks. I would just add that my orientation is toward very low risk bonds. If I want risk, I have equities. I see no reason to take risk on the "safe" side of my portfolio. So I tend to gloss over credit risk.

For those with tastes like emerging market bonds and junk, by all means use bond funds. This is where extreme diversification (like 50+ issues) is important and where managers at least theoretically have expertise that adds value in exchange for their fees. Given that we know on the equity side that manager results are indistinguishable from random luck, I am skeptical about bond managers. But I have never owned a bond fund.