Bond exchange-traded funds (ETFs) are a pretty popular type of exchange-traded fund that is renowned for exclusively investing in bonds. They are quite similar to bond mutual funds as they hold a portfolio of bonds with varying strategies and holding periods. Kavan Choksi adds that bond ETFs are managed and traded passively on major stock exchanges, much like stock ETFs. They, therefore, have high liquidity and transparency, which makes them a good addition to any investment portfolio.
Kavan Choksi shares a brief understanding of bond ETFs
As opposed to individual stocks that are sold over the counter by bond brokers, bond ETFs are traded throughout the day on a centralized exchange. The structure of traditional bonds often makes it complex for investors to find a bond having attractive pricing. However, bond ETFs are able to avoid this problem by trading on major indexes, including the New York Stock Exchange (NYSE). Hence, having some allocation of bond ETFs in the portfolio would be prudent for the investors.
Bond ETFs can provide investors with the chance to acquire exposure to the bond market with the transparency and ease of stock trading. Bond ETFs are much more liquid than mutual funds and individual bonds that tend to trade at a single price per day as the market closes. Investors, can however, choose to trade a bond portfolio even if the underlying bond market is not functioning well during times of distress. Bond ETFs additionally pay out a monthly dividend, while any kind of capital gains are ultimately paid through an annual dividend. Such dividends are treated as either income or capital gains for tax purposes.
Bond ETFs share a number of features with typical, individual bonds, including that of regular coupon payments. By choosing to invest in individual bonds, investors shall get fixed payments on a regular schedule. Such payments ideally happen every six months. On the other hand, bond ETFs basically hold assets with different maturity dates. Therefore, at any point in time, certain bonds in the portfolio might be due for a coupon payment. As a result, people choosing to add bond ETFs to their portfolio will be able to enjoy interest payment each month, with the value of the coupon varying from one month to the other. On the whole, due to its many beneficial features, bond ETFs are a great option to gain exposure to the bond market for any investor.
As per Kavan Choksi, assets in bond ETFs are changing continually and do not mature. Rather, bonds are purchased or sold off when they expire or exit the target age range of the fund. A lot of the bonds are held until maturity, as a result an active secondary market is not available for them in most situations. This makes it a complex issue to make sure that a bond ETF encompasses enough liquid bonds to track an index. The suppliers of bond ETFs are fortunately able to get around the liquidity problem by using representative sampling. This implies to tracking just a sufficient number of bonds to represent an index. The bonds used in the representative sample are ideally the largest and most liquid in the index.