Bond ETFs: why and how Bond ETFs: why and how Bond ETFs: why and how

Bond ETFs: why and how

Althea Spinozzi

Head of Fixed Income Strategy

Summary:  As interest rates peak, investors are offered the opportunity to diversify risk in their portfolio by adding bond exposure. However, gaining exposure to specific bonds might be challenging. Bonds ETFs provide an easy way to diversify within this space while maximizing liquidity and transparency.

As interest rates peak, investors are offered the opportunity to diversify risk in their portfolio by adding bond exposure.

However, trading cash bonds may be difficult for many investors as they trade over-the-counter (OTC), hence lacking the market transparency that stocks have. In some instances, especially in the high-yield corporate bond space, liquidity is extremely poor, and broker markups can be substantial.

In contrast, Bond ETFs offer diversity, liquidity, and price transparency, providing investors an effective tool to gain exposure to this market. Below, we look at the pros and cons of buying a bond ETF and highlight some instruments available in the Saxo Platform.

Bond ETFs Pros

  1. Bond ETFs offer diversification.  Through an ETFs an investor can own multiple bonds in a index, diversifying risk.
  2. Bond ETFS are liquid and price-transparent. That’s even true for the least liquid fixed income instruments such as high-yield corporate bonds. ETFs prices are published on the exchanged and updated intraday.
  3. Bond ETFs do not mature. While a bond has a specific maturity, a bond ETF needs to maintain a constant maturity by buying and selling securities actively. Therefore, it is easier for bond investors to gain exposure to a specific part of the yield curve without building a bond ladder from scratch.
  4. Bond ETFs pay a regular income. The coupon collected by the underlying securities is distributed among ETF holders.

Bond ETFS Cons

  1. There is no fixed maturity, therefore investors bear interest rate risk. When buying a cash bond, the yield can be locked until maturity. At maturity, an investor will receive the notional back. Because a bond ETF never matures, one is not guaranteed to get money back. Hence, investors bear entirely interest rate risk. Yet, bonds’ carry might serve as a buffer against such risk.

What’s the bond market outlook?

Inflation still poses a risk for investors, but the moment for increasing one’s portfolio duration may be coming at the end of the year when central banks might be forced to ease the economy. Until the case for central banks to turn dovish doesn’t materialize, we favor short-term, high-quality fixed-income securities. Please refer to Saxo’s quarterly bond outlook for details.

US Treasuries: which bond ETFs are available to trade the US yield curve?

  • iShares Short Treasury Bond ETF (SHV:xnas). US Treasury bonds with maturities of one year or less.
  • iShares 1-3 Year Treasury Bond ETF (SHY:xnas). US Treasury bonds with maturities of one to three years.
  • iShares 7-10 Year Treasury Bond ETF (IEF:xnas). US Treasury bonds with maturities of seven to ten years.
  • iShares 20+ Year Treasury Bond ETF (TLT:xnas). US Treasury bonds with maturities of more than twenty years.

Corporate bonds: which bonds ETFs can I consider?

  • Investment grade corporate bond ETFs:
    • iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD:arcx). The ETF seeks to track the investment results of an index composed of U.S. dollar-denominated, investment-grade corporate bonds.
    •  iShares Broad USD Investment Grade Corporate Bond ETF (USIG).  It seeks to track the investment results of an index composed of U.S. dollar-denominated investment-grade corporate bonds.
    • Vanguard Short-Term Corporate Bond ETF (VCSH:xnas).  It tracks the performance of the Bloomberg US Corporate 1-5 years Total Return index.
    • Vanguard Intermediate-Term Corporate Bond ETF (VCIT:xnas). It tracks the performance of the Bloomberg US Credit Corp 5-10Y index.
    • Vanguard Long-Term Corporate Bond ETF (VCLT:xnas). It tracks the performance of the Bloomberg US Corporate 10+ years Total Return index.
  • High yield bond ETFs:
    • iShares iBoxx High Yield Corporate Bond ETF (HYG:Arcx). It tracks the performance of the iBoxx USD Liquid High Yield Total Return Index.
    • SPDR Bloomberg High Yield Bond ETF (JNK:arcx). It tracks the performance of the Bloomberg High Yield Very Liquid Bond Index.
    • VanEck International High Yield Bond ETF. It tracks the performance of the BofA Merrill Lynch Global ex-US Issuers High Yield Constrained Index

Where can I find more bond ETFs in the Saxo platform?

It’s easy! Click on “TRADING” -> “SCREENER” -> screen for “ETFs” and under “CATEGORIES” select the fixed income funds you would like to visualize

Source: Saxo Platform.

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