Bonds are boring, and so are bond exchange-traded funds, right? Well, no. Actually, the bond ETF market has been heating up this year with record inflows fueled by crazy happenings in the financial markets and by the increasingly sophisticated ways investors are using bond ETFs to position their portfolios during volatile times, said people who follow this space.
Many investors probably wish bonds were “boring” like they seemingly were in the good ol’ days when financial advisors could confidently construct a 60/40 portfolio of stocks and bonds for clients. That’s where the 40% fixed-income portion provided non-correlated ballast against the more volatile 60% equities portion, while yielding sufficient income to pad a comfortable retirement.
But historically low interest rates have negatively impacted the fixed-income world at large, and that means the standard 60/40 portfolio won’t cut it for a lot of retirees. Nonetheless, bond ETFs are playing a vital role in many portfolios thanks to the increasing variety of these investment vehicles and the versatility they can add.
“There has been a proliferation of [fixed-income] ETFs products that give investors more choice,” said Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors.
There are more than 400 U.S.-listed bond ETFs, and they run the gamut from tracking large indexes like the Bloomberg Barclays U.S. Aggregate Bond Index (known as the Agg) to targeting a specific niche such as the new iShares BB Rated Corporate Bond ETF (HYBB), which focuses on the BB-rated segment of the high-yield market.
From his perch at State Street, Bartolini sees institutional investors, financial advisors and others using bond ETFs to manage portfolios both strategically and tactically.
One example of the former, he noted, is that investors can use ETFs to create a version of the broad Agg index that’s tailored to their risk-and-return assumptions. That can be done by decomposing the index based on its different maturity bands and credit sectors.
“You can create different profiles for yourself while potentially benefitting from the diversification that core bonds can give you in terms of being negatively correlated to equities,” Bartolini said.
Elsewhere, some financial advisors employ target maturity date bond ETFs to replicate bond laddering strategies consisting of bond portfolios with different maturity dates that provide predictable income while reducing reinvestment risk from fluctuating interest rates. Using ETFs to build a laddering approach is much simpler and cheaper than buying individual bonds.