After lingering in the background of the ETF industry for the last several years, fixed income funds have stepped up in recent months to become one of the primary drivers of growth. Through the first seven months of 2010, cash inflows to ETFs totaled $49 billion. Of this amount, more than $23 billion has been attributable to fixed income ETFs, reflecting that investors have become increasingly comfortable with the idea of achieving their fixed income exposure within the ETF wrapper.
The movement to bonds has also come at a time when equity market uncertainty and volatility has surged. With uncertain prospects for economic growth, the safe haven of fixed income securities has new appeal; it’s not uncommon now for even the most risk tolerant investors to have bond allocations approaching 50%.
Tremendous innovation in the fixed income ETF space has given investors more options than ever before. Once upon a time, most fixed income ETFs were broad-based funds that covered the entire universe of (or at least investment grade universe). But new products, such as target date funds rolled out by iShares and Claymore, have allowed investors options for increased granularity in constructing fixed income exposure [see Claymore Launches Maturity Date Corporate Bond ETFs].
According to our ETF screener, there are currently about 120 fixed income ETFs, a huge increase from just one year ago. The exposure offered by these ETFs is all over the board, ranging from Treasuries to municipal bonds to “junk” bonds. Below, we break down the bond ETF space into 12 different ETFdb Categories [for more ETF insights, sign up for our free ETF newsletter]:
The California Munis ETFdb Category includes funds holding bonds issued by various municipalities, including cities, counties, airports, school districts, and any other government entity below the state level in California. Given the Golden State’s ongoing financial woes, funds in this ETFdb Category can be riskier than funds focusing that diversify holdings throughout the country. The largest ETF in this category is the iShares S&P California Municipal Bond Fund (CMF).
The Corporate Bonds ETFdb Category includes funds holding bonds issued by corporate entities (generally, ETFs in this ETFdb Category limit their holdings to investment grade securities). Of the 20 ETFs placed in this category, the iBoxx $ Investment Grade Corporate Bond Fund (LQD) is by far the largest with a market capitalization of more than $12 billion. LQD covers all ends of the maturity spectrum, but there are also more targeted options available focusing on short, intermediate, and long term corporate bonds [see all of LQD's holdings here].
This ETFdb Category includes funds holding bonds issued by countries classified as emerging markets [see Why Emerging Market Bond ETFs Are Safer Than Developed Markets]. The iShares JP Morgan Emerging Markets Bond Fund (EMB) is the largest ETF is this particular category; this fund is linked to a U.S. dollar denominated emerging markets debt benchmark that tracks the total return of actively-traded debt instruments in emerging markets.
Emerging markets bonds often offer attractive returns; the majority of EMB’s assets have a strong coupon rate between 6% and 8%.
The Government Bonds ETFdb Category includes funds holding primarily bonds issued by the United States government. In addition to broad-based funds, there are a number of funds offering exposure to specific maturities in this ETFdb Category. The largest ETF in this category, the Barclays 1-3 Year Treasury Bond Fund (SHY), focuses on the short end of the maturity spectrum; at the other end are ETFs such as the Barclays 20+ Year Treasury Bond Index Fund (TLT).
The High Yield Bonds ETFdb Category includes funds that invest in bonds classified as “speculative” or “junk” by major ratings agencies. Generally “junk” bonds are defined as debt securities rated below BBB- credit quality. In order to compensate for investors for the elevated default risk, these securities often offer yields that are significantly more attractive than government bonds or investment grade corporate securities.
The largest ETF in this category is iShares’ iBoxx $ High Yield Corporate Bond Fund (HYG). HYG provides a broad representation of the U.S. dollar-denominated high yield liquid corporate bond market [see more on HYG's fact sheet]. HYG’s yield is currently around 10%, a rarity in the low interest rate environment.
The Inflation-Protected Bonds ETFdb Category includes funds that invest in Treasury Inflation-Protected Securities (TIPS). A common misconception about TIPS is that the coupon rate changes with inflation. Actually, TIPS pays out interest twice a year a fixed rate, regardless of inflation statistics; the value of the principal is adjusted based on CPI statistics. The iShares Barclays TIPS Bond Fund (TIP) is the largest ETF in this category; TIP has a market capitalization of more than $20 billion, making it one of the largest ETFs on the market [see Three ETFs To Own If Paul Krugman Is Right].
The International Government Bonds ETFdb Category includes funds holding bonds issued by foreign federal governments and are denominated in their local currencies. The Barclays Capital International Treasury Bond Fund (BWX) tops the list of this category with a market capitalization of just over $1 billion. This ETF invests in bonds issued by international governments, in local currencies, with a maturity of one year or more and are rated investment grade. BWX has more than 100 individual holdings, with debt issued by governments of Japan, Germany, and Italy among the largest individual securities [see BWX's performance charts here].
The Mortgage Backed Securities ETFdb Category includes funds that invest in primarily investment grade mortgage-backed pass-through securities issued by various agencies of the U.S. government. The largest ETF in this category is the iShares Barclays MBS Bond Fund (MBB). MBB measures the performance of investment grade fixed-rate mortgage-backed pass-through securities of GNMA, FNMA, and FHLMC.
The National Munis ETFdb Category includes funds holding bonds issued by various municipalities, including cities, counties, airports, school districts, and any other government entity below the state level. The category is broken up into general obligation and revenue bonds. iShares S&P National Municipal Bond Fund (MUB) is the largest ETF in our national munis category; MUB is a highly diversified fund with more than 800 individual securities [see more at Three ETFs To Protect Against Rising Taxes].
Similar to the aforementioned California-specific funds, ETFs in this ETFdb Category focus on municipal bonds issued within a certain state (in this case, New York). The iShares S&P NY Muni (NYF) tops a list of just 3 ETFs in this category, maintaining assets of about $75 million [see NYF's fundamentals here]. Currently, New York is also facing severe budget challenges, adding to the risk of funds in this ETFdb Category.
The Preferred Stock/Convertible Bonds ETFdb Category includes funds holding preferred stock or convertible bonds issued by companies based in the U.S. The biggest ETF in this category is the iShares S&P U.S. Preferred Stock Fund (PFF), which measures the performance of a selected group of preferred stocks. The top holdings of this fund include Wells Fargo, Ford Motor, and JP Morgan Chase [see PFF's technicals here].
ETFs in the Total Bond Market ETFdb Category include funds that offer diversified exposure to the U.S. investment grade bond markets. The securities included in these ETFs include U.S. government bonds, investment grade corporate bonds, mortgage pass-through securities, and asset-backed securities. The largest ETF in this category is the iShares Barclays Aggregate Bond Fund (AGG), which measures the performance of the U.S. investment grade bond market.
Disclosure: No positions at time of writing.