RETURNS TO EXPECT FROM BEST BOND ETFS
Here is what different Bond ETF Types currently Yield
Few nuances to remember:
- 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
table of contents
INDEPENDENT ETF REVIEW APPROACH
We have performed some in depth research because finding the right Bond Index Fund may be difficult. Because there are hundreds on them. These have some of the lowest expense ratios and are fairly liquid. Importantly, they are considered to be some of Best and Largest Fixed Income ETFs by market participants.
The purpose of this guide is to present some of the Best Bond ETFs but also metrics so that you can choose the best fit for your portfolio. We don’t go into technical details but explain concepts to be able to make the right chose. Some metrics below include Year to Date Performance, Fund Size, Expense Ratio, Risk (Duration and Spread), Yields and Last Dividends. We have included main Fixed Income Index Fund categories: Treasuries, Corporates – Investment Grade and High Yield.
Included are also amounts that the FED has purchased as part of its SMCCF Fixed Income Purchase Programme.
For simplicity, we use Index Funds and ETFs words interchangeably. For the differences see FAQ below (the specific Funds below are ETFs)
Understand Your Needs
MAIN BOND FUND CHARACTERISTICS
In order to choose the right Bond Index Fund 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 Funds. The first group is a broad category consisting of a mix of the below categories #2 Treasury, #3 High Quality Corporate and Mortgage Bonds, all usually rated Investment Grade. Importantly, these are the easiest to invest since it includes most of the high quality bond universe (therefore, we will start with them below – you may just pick one and stop there. Otherwise you may consider the other three categories)
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, both categories #3 and #4 face Default Risk. However, #4 Speculative-grade bonds are issued by companies perceived to have a lower level of credit quality compared to more highly rated #3 investment-grade, companies (Read More on Credit Ratings)
Inflation Protection, Municipal and Other Bond Type ETFs
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.
ALWAYS CONSIDER 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.
ETF UNIVERSE AND TYPE OF UNDERLYING BONDS
As you can visualize below the main categories of ETFs are #3 Investment Grade and #2 Treasuries. #1 Aggregate Funds are convenient since they include both #2 Treasuries and #3 Investment Grade (so, you just need to invest in one fund) but also High Quality Government Backed Mortgages.
The downside is that the Asset Manager will chose the proportion of each Treasuries and Corporate Bonds and yield depends on this mix as you can see in the tables below.
Relative Size of TOP 5 Funds in each of the four main ETF Categories
AGGREGATE OR CORE - BEST BOND ETFs
Core Bond ETFs - Relative Size
Core Funds - Best Bond ETF 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 (this is c. 2% higher than Treasury Bond ETF Funds alone)
- Thirdly, 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
- In conclusion, this fund should provide a good diversification for your Equity portfolio while still generating yield
Aggregate Market 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:
Aggregate Market: Best Bond ETFs for your Portfolio - Read more
|iShares Short Maturity Bond ETF (NEAR)|
|Vanguard Short-Term Bond ETF (BSV)|
|iShares Core 1-5 Year USD Bond ETF (ISTB)|
|iShares Ultra Short-Term Bond ETF (ICSH)|
|Invesco Ultra Short Duration ETF (GSY)|
TREASURY - BEST BOND ETFS
Treasury Bond ETF Funds - Relative Size
Treasury Bond Funds - 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, it is 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 zero Real Return e.g. Annual Yield is 1% while 7 Year Inflation Rate (above tables) is close to 1.1%
- Also, there is also a risk on underperformance should Inflation come back
- In conclusion, this is why we currently prefer the Aggregate Funds (Category #1) or Investment Grade Bonds (Category #3) over Treasuries
- Read more about risks and returns you can expect from US Treasury Bonds in 2020
Treasury 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:
Treasuries: Best Bond ETFs for your Portfolio - Read more
|iShares Short Treasury Bond ETF (SHV)|
|iShares 1-3 Year Treasury Bond (SHY)|
|SPDR Bloomberg Barclays 1-3 Month (BIL)|
|Vanguard Short-Term Treasury ETF (VGSH)|
|Schwab Short-Term U.S. Treasury (SCHO)|
|SPDR Portfolio Short Term Treasury (SPTS)|
|iShares 7-10 Year Treasury Bond ETF (IEF)|
|iShares US Treasury Bond ETF (GOVT)|
|iShares 3-7 Year Treasury Bond (IEI)|
|Vanguard Intermediate-Term Treasury ETF (VGIT)|
|Schwab Intermediate-Term U.S. (SCHR)|
CORPORATE BOND ETFS - INVESTMENT GRADE
Investment Grade Bond Funds
Investment Grade Funds - One of the Best Bond ETFs is iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) Review
- 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 199 bps which explains most of the difference in Yield (2.7% before and c. 1.7% after inflation) vs. Vanguard VCIT (1.9% before inflation and 1.2% after inflation)
- 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
Investment Grade 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
Investment Grade: Best Bond ETFs for your Portfolio - Read more
CORPORATE BONDS - HIGH YIELD
High Yield Bond Funds
High Yield Funds - One of the Best Bond ETFs is SPDR Bloomberg Barclays High Yield Bond ETF (JNK) Review
- Firstly, it is 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
- Secondly, the fund is well diversified with over 900 Bonds
- Thirdly, 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)
High Yield ETF List
- Below is a dashboard of the Best Fixed Income Index Funds in 2020 – High Yield Bond ETFs by Size.
- Importantly, 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 some Bonds defaulting within these Funds. As such they tend to underperform during a downturn (similar to Equities, hence lower diversification benefit)
On the Graph below High Yield is represented by (BB & B & CCC/C)
High Yield: Best Bond ETFs for your Portfolio - Read more
|iShares 0-5 Year High Yield Corporate Bond ETF (SHYG)|
|SPDR Bloomberg Barclays Short Term High Yield Bond ETF (SJNK)|
|PIMCO 0-5 Year High Yield Corporate Bond Index ETF (HYS)|
INFLATION PROTECTION / TIPS - BEST BOND ETFS
How Do Inflation Protection Bonds 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.
Inflation Protection ETF List
TIPS: Best Bond ETFs for your Portfolio - Read more
|Vanguard Short-Term Inflation-Protected Securities ETF (VTIP)|
|iShares 0-5 Year TIPS Bond ETF (STIP)|
|FlexShares iBoxx 3-Year Target Duration TIPS Index Fund (TDTT)|
MUNICIPAL / MUNIS - BEST BOND 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.
Muni ETF List
Munis: Best Bond ETFs for your Portfolio - Read more
|SPDR NUVEEN Bloomberg Barclays Short Term Municipal Bond ETF (SHM)|
|iShares Short-Term National Muni Bond ETF (SUB)|
|iShares National Muni Bond ETF (MUB)|
|SPDR Nuveen Bloomberg Barclays Municipal Bond ETF (TFI)|
|VanEck Vectors AMT-Free Intermediate Municipal Index ETF (ITM)|
|iShares California Muni Bond ETF (CMF)|
Examples of Best Bond ETFs for Equity Risk Protection
DEFINITIONS AND CONCEPTS
- Assets is a measure of the Size of the Index Fund Fund. We 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 our 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 Index Fund to generate going forward (conceptually it is the sum of Treasury Bond Yield and Spread) before taking into account inflation
- Inflation – what you need to substract to understand what is the Real Return you get from Bonds
- 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 – Index Fund price move year to date. Moves in an opposite way to changes in interest rates and spread
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. We 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
BOND ETF RISKS
BOND INDEX FUND FAQ
What is the difference between Bond Index Fund and Bond ETF?
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
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.