Choosing a suitable Fund among Best Bond ETFs – which Bond ETF should I buy?

BEST BOND ETFs TO BUY NOW

Current Annual Yields for main Bond ETF Types (vs. Inflation)

best bond etfs how much interest can you get with bonds and inflation levels etfs index investing - comparison chart
Current Yield to Maturity for different Bond ETF Categories and Time Horizons. Inflation is annualized over the period. As you can see, broadly speaking the longer the horizon the higher the return / inflation. However, Intermediate High Yield is more risky than Long Term Corporate Bonds (Investment Grade). Source: Bankeronwheels.com

Before you dive deeper into the yields in the tables below, remember that:

  • All Yields to Maturity in this Guide are before inflation
  • The only exception are Inflation Protection Bond ETFs (TIPS) that have a yield in the table after inflation (i.e. Real Yields). Therefore, if you want to compare Treasury Bond ETFs with TIPS you need to substract inflation from the Yield to Maturity. In real terms (Real Yields) returns from both of them will be similar
  • Municipal Bond ETFs may be except from certain taxes (e.g. Federal) hence the yield/dividends should be compared to yields post tax from other categories 

Year to Date Price Performance of Bond ETF Types

Source: Bankeronwheels.com

TAKE A SHORTCUT

If you’re looking for a simple Long Term Investment Strategy Portfolio with a couple of Bond ETFs read a short version of how to construct it and select the Best Bond ETFs

TABLE OF CONTENTS

ETF CATEGORIES

Here are the main Bond ETF Categories:

  • Aggregate Bond ETFs or Blend Bond ETFs are convenient since they include both Treasuries and High Quality Corporates and Government Backed Mortgages
  • Treasury Bond ETFs
  • Corporate Bond ETFs (High Quality aka Investment Grade) 
  • Niche Markets ETFs including High Yield Bond ETFs or Inflation Protection Bond ETFs

If you are looking for Bonds to hedge your Equity portfolio the best choices are Aggregate Bond or Treasury Bond ETFs

Read more about how these Bond ETFs can work as part of a wider portfolio

Best bond etfs in each category explained
Source: Bankeronwheels.com

SIZE OF TOP 5 ETFs IN EACH CATEGORY

I looked at the Main Bond ETF Categories and sizes (in $M) of their respective TOP 5 Funds:

The industry is dominated by 3 Asset Managers

  • BlackRock’s iShares
  • Vanguard ETFs
  • State Street’s SPDR ETFs

Why is size of the ETF important?

If you have invested in ETFs you may have witnessed a closure of a Fund because commercially it wasn’t profitable. It’s not a problem for liquid markets but Bonds typically aren’t and small funds:

  • Are linked with risk of closing down
  • When they close down there is a risk the liquidation won’t be executed at best prices

Note that most of the ETFs below have a minimum size anyway and are considered benchmarks by market participants (I’ve not considered ETFs below $1bn AUM with a couple of exceptions)

Understand Your Needs

BOND ETF CHARACTERISTICS

In order to choose the right Bond ETF for your portfolio you need to assess your needs based on two factors:

  • Your Risk Tolerance
  • Your Time Horizon
 

Risk Tolerance (Credit Risk)

 

Aggregate Bond Funds

Also called Core or Blended Bond ETFs. The first group is a broad category consisting of a mix of  Treasuries, High Quality Corporates and Mortgage Bonds, all usually rated Investment Grade. Importantly, these ETFs are the easiest to invest since they include most of the high quality bond universe (therefore, I will start with them below – you may just pick one and stop there)

 

US Treasury Bond Funds

The second group consists of Treasury Bonds that are considered virtually risk-free (no Default Risk). However, yields are currently very low and after accounting for inflation even negative for short term / intermediate

 

High Quality Corporate Bond Funds 

The third group consists of bonds called Investment grade bonds – considered relatively safe because the resources of the issuers are sufficient to indicate a good capacity to repay obligations (usually issued by Blue-Chip Companies)

When you review the below tables keep in mind that conceptually the higher the “Spread” the higher the Credit Risk (although Spreads tend to also increase with time horizon, more about this here

 

High Yield Bond Funds

The highest yielding bonds also known as speculative. Importantly, all Corporate Bonds face Default Risk. However, Speculative-grade bonds are issued by companies perceived to have a lower level of credit quality compared to more highly rated investment-grade companies (Read More on Credit Ratings)

 

Inflation Protection ETFs and Municipal Bond ETFs

Inflation Protection Treasury Bond ETFs (also known as TIPS), Municipal Bond ETFs (also known as Muni ETFs) have their specific characteristics. Inflation Protection ETFs are as safe as Treasuries and will generate Real Rates of return (which are currently negative!) but protect you should inflation pick up (the yield is the sum of the one you see in the table below and inflation, since their cash flows are adjusted for inflation). Municipal Bonds are financing local governments and may have higher Yield than Treasuries (but also more risk) and potentially preferential Tax treatments
 

Time Horizon (Interest Rate Risk)

Firstly, It is considered good practice to match your time horizon (Short Term, Intermediate or Long term) with the appropriate Fund Maturity Profile.  All bonds carry Interest Rate Risk. Note that the longer the duration the more you can gain or lose from moving interest rates

Secondly, you need to understand why the value of Bonds decreases with rising interest rates. Think of it as an opportunity cost for an investor to keep holding on on Bonds that are generating less than newly issued at higher interest rates. That said, a bond will converge towards par (100) on maturity, thus conceptually you don’t take much interest rate risk when holding bonds to maturity. 

Look at the “Duration” value in the below tables 

ALWAYS THINK ABOUT INFLATION

Before any Bond ETF analysis below don’t forget to have a quick look at expected Inflation.

Always compare expected ETF Yield to (broadly) same horizon of expected Inflation.

By substracting inflation from the Nominal Yield in the below ETF tables you will understand what is the real return you can expect accounting for changes in consumer prices

E.g. for Intermediate Bond Categories you can take Medium Term Inflation etc.

best bond etfs inflation rate - breakeven rates from TIPS treasury inflation protected securities - different real yields and nominal yields bonds fixed income

ETF UNIVERSE AND TYPE OF UNDERLYING BONDS

The Bond ETFs are sorted by Term that you should match with your investment horizon:

  • Short Term Bond ETFs (up to 3 year duration)
  • Intermediate Bond ETFs (3 to 10 year duration)
  • Long Term Bond ETFs (usually duration over 10 years)

AGGREGATE OR BLEND BOND ETFS

Best Bond ETFs by Relative Size

best bond etfs in core category - relative size of aggregate core ETFs - ishares spdr vanguard AGG BND BIV SCHZ BLV BSV

One of the Best Bond ETFs is iShares Core Total USD Bond Market ETF (IUSB)

  • The fund is fairly safe Fund for Coronavirus Market Environment with close to 65% of Bonds in the highest rating category (AAA)
  • The ETF is generating one of the highest yields in its category in this low Yield environment 
  • Outside of Government Bonds and Mortgage backed Securities from government-backed entities like Fannie Mae and Freddie Mac the incremental Yield comes from a handful on Financial Institutions like Morgan Stanley or Industrials like Oracle, Verizon or Dell
  • This ETF should provide a good diversification for your Equity portfolio while still generating yield
BOND ETF TABLES

UNDERSTAND HIGH LEVEL CONCEPTS

  • Assets is a measure of the Size of the Index Fund Fund. I generally only list Index funds with a minimum size of $1bn that are widely used by Investment Professionals. The exceptions are Niche Funds (Category 4) which are smaller by definition
  • Expense Ratio – keep it low to generate more return. In order to do that plug two expense ratio numbers for comparison in the ETF Fee Calculator too see how it impacts your returns over the long term
  • Duration is a measure of Interest Risk for Bonds (more on Interest Rate Risk). 
    A rule of thumb is to align the average maturity of a bond ETF with the length of time that you’ll have your money invested in that ETF. Also, that the longer the duration the more you can gain or lose from moving interest rates (for Treasuries, it will also provide a more effective diversification for Equities since rates tend to fall in a downturn)
  • Spread is a measure of Credit Risk for Corporate Bonds (more on Credit Risk). Broadly speaking it is the additional return (in basis points 100 bps = 1%) over US Treasuries. Therefore, the higher it is the riskier the Bonds
  • Yield to Maturity – is what you can expect the Bond ETF to generate going forward (conceptually it is the sum of  Treasury Bond Yield and Spread) but before taking into account inflation
  • Dividend Yield – shows how much was generated over the past 12 months. It can also include Capital Gain. However, past dividend yield is not necessary an indication of future dividends (Example for Treasuries described here)
  • YTD Return Bond ETF price move year to date. Moves in an opposite way to changes in interest rates and spread
  • MAX Drawdown – is the maximum historical Bond ETF price decline from peak. As you can see it it in line with a combination of either or both duration / spread that are the key risk metrics for Bonds. However, this should not be seen in isolation but rather how the drawdowns behave combined in a portfolio with Equities

Aggregate Bond ETF Category - Best Bond ETF List

Below are some of the Best Fixed Income ETFs in 2020 as regarded by Market Participants in Category “Aggregate Bond ETFs” sorted by by Size:

compare best bond etfs - aggregate bond ETF - compare with other funds its duration expense ratio yield dividend returns spread oas short intermediate long
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Aggregate Category - Best Bond ETFs Links

TREASURY BOND ETFS

Best Bond ETFs - Relative Size

best bond etfs in treasury category - relative size of treasury ETFs - ishares spdr vanguard SHV SHY BIL TLT IEF GOVT IEI

One of the Best Bond ETFs is iShares US Treasury Bond ETF (GOVT)

  • Firstly, this fund provides with the best Yield in the Intermediate category
  • Secondly, Treasuries are the safest Investment that benefits from flight to quality should the market deteriorate (yes, yields can go even lower from here which would boost this fund)
  • However, after accounting for Inflation like most of the below Funds, GOVT ETF yields negative Real Return e.g. Annual Yield is 0.8% while 7 Year Inflation Rate (above tables) is close to 1.5%
  • Also, there is also a risk on under-performance should Inflation come back
  • In conclusion, this is why I currently prefer the Aggregate Funds (Category #1) 
 

Read more about risks and returns you can expect from US Treasury Bonds in 2020

Treasury Bond ETF Category - Best Bond ETF List​

Below are some of the Best Fixed Income Index Funds in 2020 as regarded by Market Participants in Category “Treasury Bond ETFs” sorted by Size:

Best bond etfs - Treasury Bond ETF - iShares US Treasury Bond ETF (GOVT) - compare with other funds its duration expense ratio yield dividend returns spread short intermediate long
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Treasuries - Best Bond ETFs Links​

CORPORATE BOND ETFS

Best Bond ETFs by relative Size

best bond etfs in corporate bond category - relative size of investment grade ETFs - ishares spdr vanguard LQD VCIT VCSH IGSB IGIB FLOT

One of the Best Bond ETFs is iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)

  • Great Brand: LQD is perhaps the most recognizable name in Corporate ETF space and it is the #1 on FED SMCCF Purchase List in absolute amount
  • Longest Track Record: Established in July 2002, it has the longest track record of all the reviewed Funds
  • Liquid and diversified: Very liquid and diversified across over 2,200 Bonds
  • High Yield: With a longer term and marginally more aggressive profile the spread is higher at 182 bps which explains most of the difference in Yield (2.4% before and c. 0.9% after inflation) vs. Vanguard VCIT 
  • Strong Sponsor: BlackRock provides better transparency of holdings and analytics
  • Importantly, the Investment Grade sector benefits from the support of the FED that has started purchasing Bonds in May 2020

Click here full review of the TOP 3 Investment Grade ETFs that the FED is currently buying

SMCCF FED ETF purchase programme - quantitative easing trading history LQD VCIT VCSH VCLT
FED Corporate Bond ETF Purchases - Click on the chart to read the review of the Funds

Corporate Bond ETF Category - Best Bond ETF List

Below are some of the Best Fixed Income Index Funds in 2020 as regarded by Market Participants in Category “Investment Grade ETFs” sorted by Size. If you want to understand how the Spread (Credit Risk) for Investment Grade Bond Universe has evolved over time check FED data

best bond etfs - corporate investment grade
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Corporate Category - Best Bond ETFs Links

HIGH YIELD CORPORATE BOND ETFS

Best Bond ETFs by relative Size

best bond etfs in high yield category - relative size of high yield ETFs - ishares spdr vanguard hyg jnk shyg sjnk hyls

One of the Best Bond ETFs is SPDR Bloomberg Barclays High Yield Bond ETF (JNK)

  • JNK has a High Risk / Reward investment with substantial Credit Risk e.g. over 10% is in Energy Sector alone with other risky sectors like Aircraft part manufacturers
  • The fund is well diversified with over 900 Bonds
  • Interest Risk is relatively lower to other categories because the Bonds are floating (not fixed) 
  • The FED is buying JNK ETF as part of its ETF Purchase Program (SMCCF)
  • However, close to 15% of the Fund is Rated CCC or lower with high Default Risk (see chart below that indicates risk before taking into account Coronavirus Market)

Before you consider High Yield...

  • This is the riskiest part (high risk / high returns) of the mainstream ETF Bond Universe (you can observe how the Spreads are much wider than the Investment Grade category). 
  • Remember, it is not unusual to see Bonds defaulting within these Funds. As such they tend to underperform during a downturn (similar to Equities, hence lower diversification benefit)
  • The ETFs have very high correlation to Equities providing very poor diversification

 

Defaults are frequent - On the graph below High Yield is represented by (BB & B & CCC/C)

High Yield starts below BBB- while default are usually below 5% for Investment Grade. Source: S&P Global Fixed Income Research

The current (above) environment High Yield defaults are expected to triple according to S&P. While their annual rate was around 3% it is expected to jump to c. 10% in the next 12 months

High Yield Bond ETF Category - Best Bond ETF List

Best bond etfs high yield ETF - SMCCF FED SPDR Bloomberg Barclays High Yield Bond ETF (JNK)
Click to enlarge

High Yield Category - Best Bond ETFs Links

INFLATION PROTECTION / TIPS BOND ETFS

INFLATION PROTECTED BOND ETFS

UNDERSTAND HOW REAL YIELDS WORK

What is the difference between Treasuries and TIPS if real rates on them are roughly the same?

The real yield may be the same but they won’t react the same way to inflation / deflation. TIPS will protect you against inflation but will under-perform if inflation turns out lower than expected.

For Inflation Protected Bonds, both Bond Face Value and coupon are adjusted to inflation so you get inflation protection. The downside is limited since you always get par price back. However, since inflation is much more common over longer time periods Bond’s face value would have gone up since issuance. This means that should price levels drop the face value will be reduced up to the floor level. If inflation drops more than expected Treasuries will outperform TIPS

In the below tables the Yields are Real i.e. you need to add inflation to get the nominal yield that you will get from these Bonds (it’s just a market convention)

Inflation Protection Category - Best Bond ETF List

Click to enlarge

TIPS - Best Bond ETFs Links

MUNICIPAL BOND / MUNI ETFS

Muni Bond ETFs Characteristics

Muni bond ETFs are exempt from federal income tax but may be subject to an investor’s state and local income taxes. Muni Bond ETFs are especially advantageous for high earners with highest tax rates. Given their increased risk profile these tend also to yield more than Treasuries. 

Yields tend to correlate with risks e.g. SPDR Nuveen Bloomberg Barclays High Yield Municipal Bond ETF (HYMD) – last of the list is exposed to local entities rated below Investment Grade. Its top exposures include Puerto Rico (High Yield), Ohio and California. The Long term funds have a higher interest rate risk as duration is between 6 and 10 years. 

Municipal Bonds Category - Best Bond ETF List

best bond etfs - MUNIs - municipal index funds and etfs - short term intermediate long term assets expense ratio duration yield dividend spdr ishares vaneck vectors invesco
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Munis - Best Bond ETFs Links

BOND ETFS THE FED BUYING NOW

Below is the full list of the Secondary Market Corporate Credit Facility (SMCCF) Purchase Programme of the Federal Reserve. I have also discussed it here

The objective as stated by the FED is “purchase of secondary market corporate bonds issued by investment grade U.S. companies or certain U.S. companies that were investment grade as of March 22, 2020, as well as U.S.-listed exchange-traded funds whose investment objective is to provide broad exposure to the market for U.S. corporate bonds”

FED SMCCF ETFs

FED SMCCF Secondary Market Corporate Credit Facility ETF Index Funds Fixed Income Bonds - best bond etfs
List of SMCCF Holdings as of May 2020

BOND ETF RISKS

I have written about the risks of Bond ETFs as it relates to the questions raised by the Coronavirus Market Crash. Read why Bond ETFs are generally safe.

BOND INDEX FUND FAQ

What is the difference between Bond Index Fund and Bond ETF?
difference index mutual funds and etfs comparison diversification exchange trading pricing fees commissions tax

Fundamentally, the strategy is the same:

1. They track an Index and replicate its performance rather than making active bets
2. They have low fees (expense ratios)
3. They are well diversified
4. They are mainly run by the same Fund Managers (BlackRock, Vanguard, State Street)

But there are technical differences:

1. An Index Fund in a Mutual Fund and trades less frequently while an ETF trades like a Stock (continually)
2. Expense Ratios (Fees) are usually higher for Index Funds vs. ETFs
3. Index Funds can have exit fees
4. However, ETFs can have trading commissions whereas Index Funds usually don’t
5. There could be a minimum initial investment in an Index Fund vs. none for ETFs
6. There could be tax related nuances depending on your geography

We mainly talk about ETFs here above since they are more convenient to trade throughout the day and have more liquidity.

What is the best Bond Index Fund?

iShares Core Total USD Bond Market ETF (IUSB)
iShares US Treasury Bond ETF (GOVT)
iShares Broad USD Investment Grade Corporate Bond ETF (USIG)
SPDR Bloomberg Barclays High Yield Bond ETF (JNK)

Are the Best Bond ETFs for Q3 2020 in their respective categories assuming an Intermediate Time Horizon with 5 to 10 year duration and generating the highest Yields

Can Bond ETFs lose money?

Yes. The value of Bonds decreases with rising interest rates.
Think of it as an opportunity cost for an investor to keep holding on on Bonds that are generating less than newly issued at higher interest rates. Individual bonds don’t have that risk if you hold to maturity.
ETFs never mature and Bonds are rolled so some risk remains. But you can reduce risk by choosing Short Duration ETFs at the expense of lower Yield.

Do Bond Index Funds have a maturity?

Bond funds do not have a fixed rate of maturity instead Bonds are rolled i.e. they include many bonds that are added or removed during the time you own the fund. It is good practice to match your investment horizon with the category of the fund (short / intermediate / long term)

Do Bond Index Funds pay interest or dividends?

While the underlying Bonds pay interest on a agreed schedule the Funds will pay this income in form of dividends

How do you choose a fixed income ETF?

Understand your risk tolerance for Credit Risk
Define your time horizon for ETF Category
Minimize Fees
Maximize Current Expected Yield

What is the difference between Treasuries and TIPS?

The real yield may be the same but they won't react the same way to inflation / deflation. TIPS will protect you against inflation but will under-perform if inflation turns out lower than expected.

What are the biggest Bond ETFs?

Some of the biggest reference Bond ETFs include iShares Short Treasury Bond ETF (SHV), iShares 7-10 Year Treasury Bond ETF (IEF), Vanguard Short-Term Corporate Bond ETF (VCSH),iShares 20+ Year Treasury Bond (TLT), iShares National Muni Bond ETF (MUB), Vanguard Intermediate-Term Corporate Bond ETF (VCIT), iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), Vanguard Long-Term Corporate Bond ETF (VCLT) and SPDR Bloomberg Barclays High Yield Bond ETF (JNK)

Which ETFs it the FED buying?

The 5 largest ETFs that the FED is buying are: iShares iBoxx US Dollar Investment Grade Corporate Bond ETF, Vanguard Intermediate-Term Corporate Bond ETF, Vanguard Short-Term Corporate Bond ETF, iShares iBoxx High Yield Corporate Bond ETF, SPDR Bloomberg Barclays High Yield Bond ETF

What are Best bond ETFs for recession?

Best Bond ETFs for recession are Treasury Bond ETFs, Aggregate or Core Bond ETFs and to some extent Investment Grade Bond ETFs. High Yield Bond ETFs are correlated to Equities and very high risk.

What are recession-proof mutual funds?

Best Index Funds for recession are Treasury Bond ETFs, Aggregate or Core Bond ETFs and to some extent Investment Grade Bond ETFs. High Yield Bond ETFs are correlated to Equities and very high risk.

What are best short term MUNI Bond ETFs?

Best Short Term fund include SPDR NUVEEN Bloomberg Barclays Short Term Municipal Bond ETF (SHM) and iShares Short-Term National Muni Bond ETF (SUB)

What are best intermediate MUNI Bond ETFs?

Best Intermediate Muni Bond ETFs include iShares National Muni Bond ETF (MUB), SPDR Nuveen Bloomberg Barclays Municipal Bond ETF (TFI), VanEck Vectors AMT-Free Intermediate Municipal Index ETF (ITM) and iShares California Muni Bond ETF (CMF)

What are best Long Term MUNI Bond ETFs?

Best Long Term Muni Bond ETFs include VanEck Vectors High-Yield Municipal Index ETF (HYD),Invesco National AMT-Free Municipal Bond ETF (PZA),Invesco Taxable Municipal Bond ETF (BAB) and SPDR Nuveen Bloomberg Barclays High Yield Municipal Bond ETF (HYMD)

DISCLAIMER – the views expressed here are my own personal views. The information provided is general in nature only and does not constitute personal financial advice. Also, you should consider the appropriateness of the information having regard to your objectives, financial situation and needs, and seek professional advice where appropriate. 

This website is not affiliated with any of the investment firms for which products are described here.  These are meant to be illustrative investments. Also, please remember that past performance may not be indicative of future results. Importantly, different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this  newsletter (article), will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. 

POPULAR INVESTMENT GUIDES

My fundamental reviews of Equity ETFs and Asset Allocation include:

My fundamental reviews of Bond ETFs include:

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Jesse32
Jesse32
3 months ago

This is great and presented in a concise manner. Exactly what I’ve been looking for. Sometimes too much choice is confusing. These main funds are more than enough for the average investor looking deploy savings through a diversified portfolio. How frequently will you update these tables? Thank you!

Jesse32
Jesse32
3 months ago

Subscribed

Paolo
Paolo
2 months ago

Could you please add tickers? Much easier to trade. Thanks!

JohnPF12
JohnPF12
2 months ago

Very interesting article

significantnumbersRE
significantnumbersRE
2 months ago

Looks good and its definitely helpful! I would just add that it might be worthwhile to include max drawdowns to the KPIs you are benchmarking as stability of the invested principal is quite a pertinent consideration when choosing bond funds

Gony
Gony
1 month ago

Probably the most comprehensive guide for Fixed Income ETFs