Mutual Fund News
HAPPY ANNIVERSARY BOND ETFS
Right smack in the midst of a bear market for U.S. equities, the first four bond ETFs started trading 15 years ago this week. Fast forward to today, and U. S. listed bond ETFs have pulled in more than $530 billion of net assets.
The initial bond ETF provider, Barclays Global Investors, was acquired by BlackRock in 2009 and today the combined iShares division has since expanded its lineup. CFRA currently ranks 76 iShares bond ETFs and a total of 239 across a range of providers.
Bond ETFs have gained traction amid adoption by retail investors, advisors and institutional investors. However, some investors still prefer gaining active exposure through a mutual fund wrapper or owning individual bonds with a more precise approach.
CFRA sees merits in all three investment products and has research to help those with a preference for one over another.
To commemorate the launching of the original four ETF products, iShares 1-3 Year Treasury Bond ETF (SHY 85 Overweight), iShares 7-10 Year Treasury Bond ETF (IEF 107 Overweight), iShares 20+ Year Treasury Bond ETF (TLT 125 Marketweight) and iShares iBoxx $ Investment Grade Corporate Bond ETF. (LQD 121 Overweight), the CFRA's put together a list of 15 reasons to consider bond ETFs.
In this article, we list the first seven and our next installment of Trends & Ideas "THE 15 YEAR ANNIVERSARY FOR FIXED INCOME ETFS", will cover the remaining eight. Let's get started.
1) Robust Secondary Market
While individual corporate bonds, including some of the approximately 1,800 holdings of LQD, do not trade every day, LQD trades more than 5 million shares on a daily basis. According to Steve Laipply, Head of US iShares Fixed Income Product Strategy, in the ten-year period ended June 2017, five times as much trading in LQD took place in the secondary market than the primary market. Meanwhile, across the industry fixed income ETF trading has grown at approximately 30% CAGR in the past ten years.
2) Market Liquidity
Some pundits in the asset management industry and the press raise theoretical concerns about the liquidity of bond ETFs. Yet, real-world data suggests investors flock to certain bond ETFs when they seek to trade in or out of the asset class. For example, on June 24, 2016, the day after the Brexit vote, an above-average 31 million shares were traded in iShares iBoxx $ High Yield Corporate Bond ETF (HYG 89 Overweight). Meanwhile, 25 million shares of HYG traded on November 9, 2016, following the Trump election. HYG traded 14 million shares on a daily basis in the past month.
3) Low Trading Costs
Aided by the high volume, HYG and LQD are two examples of ETFs traded frequently enough to enable investors to transact with minimal bid/ask spreads. But, those are not just rare examples, as CFRA has data on 94 bond ETFs with bid/ask spreads of $0.03 or lower. Other, younger ETFs that have minimal trading costs include SPDR Bloomberg Short Term High Yield Bond (SJNK 28 Overweight) and PowerShares Variable Rate Investment Grade Portfolio (VRIG 25 NR).
4) Expense Ratios
While the four inaugural bond ETFs continue to charge 15 basis points, considerably cheaper than most active bond mutual fund, many younger products have launched with lower fees. Indeed, 44 bond ETFs charge a gross fee of 10 basis or less, including 4 basis points for Schwab US Aggregate Bond ETF (SCHZ 52 Overweight) and Vanguard Total Bond Market Index Fund (BND 82 Marketweight). In contrast, Dodge & Cox Income Fund (DODIX 14 *****), the largest actively managed fund in the comparable Lipper Core Bond fund peer group charges 43 basis points, a fee that is nearly half of the 0.76% mutual fund peer average.
5) Style Consistency
Bond ETFs and mutual fund are frequently used in asset allocation strategies to provide diversification and manage risk. While index-based BND and SCHZ have exposure to only investment-grade rated bonds, ensuring style consistency, active core bond funds such as DODIX have flexibility to own some high-yield bonds. Indeed, DODIX has an 8% stake in such speculative-grade funds. While DODIX ranks favorably to CFRA, investors need to understand its exposure and how it fits into a portfolio that might also include a separate high-yield fund.
6) Tax Efficiency
Unlike a mutual fund shareholder, bond ETF investors are less likely to incur meaningful capital gain taxes until their shares are sold. Whereas a bond fund manager may need to sell bonds in the shared portfolio to meet redemptions, much of the bond ETF trading action happens in the secondary market. Meanwhile, the creation/redemption share process, common also to equity ETFs, helps keep the investment relatively tax efficient.
7) Low Cost Cash Alternative
Investors seeking to benefit from the liquidity of ETFs can also consider some products as an alternative to money markets. PIMCO Enhanced Short Maturity Active ETF (MINT 102 Overweight) and Goldman Sachs TreasuryAccess 0-1 Year ETF (GBIL 100 Overweight) are examples of low-cost ultra-short-term ETFs covered in this space. MINT has a higher 30-day SEC yield (1.5% vs. 0.9%) than GBIL, but takes on some additional credit risk.
Keep an eye out for a discussion of the remaining eight reasons to consider bond ETFs in a Trends & Ideas companion article later today on this platform.