What Is a Bond ETF?

Views 3836Apr 29, 2024

Bonds don’t make headlines the way certain stocks do, but the bond market is far more vast and interconnected than the markets for equities. Investing in bonds used to be more difficult since they don’t trade on exchanges and lack the liquidity of stocks.

Today, bond exchange-traded funds (ETFs) provide simple and diverse exposure to debt markets without forcing investors to jump through too many hoops. Moomoo clients can build a bond ETF portfolio in just a few minutes, although due diligence is still required when investing in bonds. Bonds are generally less risky than stocks, but that doesn’t mean a risk-free return.

Bond ETFs Explained

Investors looking to add bonds to their portfolios can benefit from ETFs. Bonds are debt securities issued by governments and corporations. Bonds function as loans with a maturity date and a set return rate. The initial investment is the principal, due back to the investor at the end of the bond term. Bonds also deliver periodic interest payments known as coupons.

ETFs are a collection of securities trading in a single basket that investors can purchase on an exchange. Unlike bond mutual funds, which investors can only purchase at the end of a trading session, ETFs can be bought and sold at any time as long as markets are in session. In addition, bond ETFs can pay a monthly dividend coupon to investors.

ETFs may provide an easy way for investors to diversify their portfolios since a single fund can contain hundreds of different securities. And since ETFs trade on exchanges like the New York Stock Exchange or the Nasdaq exchange, liquidity issues are infrequent. Bond investors no longer have to buy directly from bond brokers or the U.S. Treasury to get fixed-income exposure.

Types of Bond ETFs

Bond ETFs are far from a one-size-fits-all investment. Instead, bonds are divided by issuer, risk level and duration, so investors of all stripes can find something worthwhile for their portfolio. Here are 10 examples of bond ETFs.

1. Multi-Sector Bond ETFs

A multi-sector bond ETF functions like a broad market stock ETF does in the equity realm. These funds own all kinds of bonds, such as short- and long-duration government, international and corporate bonds. ETFs like these are intended for investors who want broad exposure to the fixed-income market.

2. Short-Term Government Bond ETFs

The U.S. Treasury sells five different types of marketable securities with varied durations and rates. Short-term U.S. government bonds (Treasury Bills and Notes under five years) are among the safest investments available.

3. Long-Term Government Bond ETFs

In addition to Treasury Bills and short-dated Notes, the government sells 10-year Notes and even longer-dated Treasury Bonds. Treasury Bonds have a maximum duration of 30 years. Long-term bonds usually offer better returns than short-term ones but face more interest rate risk.

4. U.S. TIPS ETFs

One of 2021 most popular investments was Treasury Inflation-Protected Securities (TIPS), which links the investor’s principal (or par value) to the Consumer Price Index (CPI). If inflation is high, TIPS provide higher returns. Conversely, deflation decreases the par value. TIPS have 5, 10 and 30-year durations.

5. Mortgage-Backed Securities ETFs

Mortgage-backed Securities (MBS) are bond-like instruments backed by mortgage payments. Issued by government agencies and private banks, MBS bonds can be sold as pass-throughs (a pool of mortgages) or collateralized (a pool of securities). These securities have more risk than government bonds as they’re only as safe as the mortgages backing them.

6. Municipal Bond ETFs

Municipal bonds (or munis) are government debt issued by states, counties or cities. Government entities sell these bonds to fund projects or service debt from daily operations. Investors like municipal bonds because they’re (mostly) free from federal taxation.

7. Corporate Bond ETFs

Companies must also raise money, and issuing stock isn’t always the best choice. Corporate bonds are debt securities like loans with varied durations and interest rates. Corporate debt has risk ratings based on the financial standing of the issuing firm.

8. High-Yield Bond ETFs

High-yield bonds are riskier debt securities that pay higher interest rates but also put more default risk on the buyer. High-yield bonds are usually issued by companies with some sort of ongoing financial burden.

9. Developed Market International Government Bond ETFs

Bond investors can purchase government debt from around the world using international government bond ETFs. Developed market bonds come from stable countries with strong economies, which pay lower rates but have lower default risk than emerging market bonds.

10. Developed Market International Corporate Bond ETFs

Investors can also access corporate bonds from stable international companies through bond ETFs. International corporate bond ETFs tend to hold debt from strong companies in countries with stable governments and less meddlesome regulations.

Investment Process

Bond ETF investors have an advantage over traditional bond investors. You won’t need to create an account on TreasuryDirect or use a specific bond broker. Here’s how to invest:

Determine how much risk you want to take. Short-term government bonds have the lowest risk (and returns), but corporate bonds usually offer better interest rates (and higher risk).
Evaluate and pick the appropriate investments.
Open an account with a brokerage with shares of your desired ETFs.
Fund your account, purchase your shares and monitor your investments.

Advantages of Investing in Bond ETFs

Liquidity: Bond ETFs can be traded on exchanges.
Simplicity: Gain exposure to the whole market with a single security.
Transparency: All holdings are disclosed in the ETF prospectus.
Diversification: You can invest in bonds across regions and risk levels.
Cost Efficiency: Most brokers have commission-free ETF trading.

Cons of Investing in Bond ETFs

Watch ETF expense rates. Make sure you aren’t paying too much for simple exposure.
Many bonds have principal protection; bond ETFs do not.
Since bond ETFs hold a variety of securities, bond ETF coupon rates can fluctuate.

Bond ETFs Offer Simplicity and Safety to Investors

Bond ETFs are a convenient alternative to traditional bond investing. Bond ETF buyers can gain exposure to various government and corporate debt levels as quickly as they would buy stocks. However, investors must still understand the objectives of their ETFs and refrain from paying high expenses that degrade returns.

Frequently Asked Questions

1. Are bond ETFs negatively correlated to stocks?

Bonds tend to do well during periods of uncertainty as investors ditch riskier equities for the security of bonds, especially Treasuries.

2. Do bond ETFs pay monthly dividends?

Yes, bond ETFs distribute the coupons they collect through monthly dividends, although the dividend amounts can vary based on the fund’s holdings.

Disclosures:

Important Information: Before investing in an ETF, you should read both its summary prospectus and its full prospectus, which provide detailed information on the ETF’s investment objective, principal investment strategies, risks, costs, and historical performance (if any). You can find prospectuses on the websites of the financial firms that sponsor a particular ETF, as well as through your broker. A Word About Risk: Investment returns will fluctuate and are subject to market volatility, so that an investor's shares, when redeemed or sold, may be worth more or less than their original cost. ETFs are subject to market volatility and the risks of their underlying securities, which may include the risks associated with investing in smaller companies, international securities, commodities, fixed income, and more. An ETF may trade at a premium or discount to its net asset value (NAV).