What is a bond ETF
A guide to bond ETFs or bond exchange traded funds.
A bond ETF or exchange traded fund is a portfolio of bond investments that is traded on a stock exchange such as the London Stock Exchange. This allows investors to buy and sell the ETF as if they were trading a stock.
ETFs add new bonds when they are issued and reinvest the cash they receive from maturing bonds, so bond ETFs can be bought and held ongoing.
Are bond ETFs the same as bond index funds?
In the vast majority of cases index funds and ETFs are passive strategies, aiming to closely match the return of an index.
The core difference is that unlike index funds, ETFs can be traded throughout the day on the stock market, much like individual shares. For long-term investors, the difference is not important.
Index funds are open-ended funds. They are collective investments that allow investors to pool their money together. These funds do not trade on the stock market, but instead price their investments daily.
Index funds own the same investments as stock exchange-listed bond ETFs and fulfil the same purpose for investors, for a similar annual fee.
Some bond ETFs differ in being actively managed, in which a fund manager picks which bonds they think will outperform the market. This ETF type is popular in the US, but are not widely available for UK investors.
Instead, investors who want active management should consider bond funds or investment trusts – which are structured like mutual funds.
Advantages of bond ETFs
Bond ETFs can offer access to thousands of different bonds through just one trade.
Simple and cost effective.
Good diversification, which lowers risk.
Can be traded instantly, allowing investors to make the most of current trading opportunities.
Lower maintenance than owning bonds directly.
They own bonds that are sometimes difficult to trade, so allow investors to own less liquid bonds.
Disadvantages of bond ETFs
- In periods of market stress the value of the bonds in a portfolio may drop suddenly.
- The net asset value (value of the ETF’s underlying investments) can diverge from the ETF’s share price, leading to discounts and premiums appearing. This means investors risk overpaying.
- An actively managed bond fund – run by a professional investor – have the ability to outperform bond ETFs. There are, however, no guarantees.
How bond ETF pricing works
There’s an offer and bid price for an ETF. The offer (or ‘ask’) price is the market price to purchase the ETF, while the bid price is the market price at which the ETF can be sold. The difference between the two is known as the ‘spread’.
For large ETFs, there is not much difference between the offer and the bid price as they are heavily traded, but smaller ones may have a larger gap.
Index-linked bond ETFs only have one price.
How do interest rates affect bonds?
The outlook for bonds is heavily impacted by interest rates. Higher rates are bad for bond prices, while falling rates are good for bond prices. The longer the maturity date of a bond, the more it is influenced by rising and falling interest rates.
One of the most popular bond ETF strategies tracks the “global aggregate bond” universe, or simply global bonds from different governments and companies.
This basket of bonds will begin to yield more when interest rates rises but the value of the portfolio could fall. If rates fall then its yield will decline, but the value of the bonds may rise.
Bond ETF FAQs
The value of your investments may go down as well as up. You may not get back all the money that you invest. If you are unsure about the suitability of an investment product or service, you should seek advice from an authorised financial advisor.