Bond ETFs: 12 Stops Along The Risk/Return Spectrum

by on November 2, 2010 | ETFs Mentioned:

As investors have become more comfortable with the marriage of fixed income exposure and the ETF wrapper, billions of dollars have flowed into bond ETFs in recent years. Impressive innovation in the space has provided investors with more options than ever before, including enhanced granularity in virtually every corner of the fixed income market. Still, the majority of fixed income ETF assets are concentrated in a handful of ultra-popular funds offering broad exposure to investment grade bonds and more targeted exposure to inflation-protected securities. The five largest bond ETFs include two tracking the Barclays Capital Aggregate Bond Index (AGG and BND) and another linked to the Barclays Capital U.S. TIPS Index (TIP), as well as funds focusing on investment grade corporate bonds (LQD) and short-term Treasuries (SHY). These five funds account for about half of all assets in fixed income ETFs.

With nearly 115 non-leveraged bond ETFs now available to U.S. investors, there is clearly a lot more to the fixed income ETF universe than the five super-tickers that account for a huge slug of all assets. The 100+ fixed income ETFs offer investors exposure to a wide variety of regions, bond types, durations, and credit qualities, giving fixed income investors all the tools they could possible need to construct targeted exposure. Below, we profile a dozen lesser-known ETFs that fall along the risk/return spectrum, ranging from a virtually risk-free to a fund comprised of the highest-yielding securities on the market [for more ETF insights, sign up for our free ETF newsletter]:

ETF 30-Day Yield
MINT 0.81%
MBB 0.96%
PRB 1.02%*
VCSH 1.68%
PICB 2.63%
BABZ 3.20%
CWB 3.36%
ELD 3.43%
EDV 4.17%
PHB 5.59%
PCEF 8.14%
HYD 8.53%*
*Tax equivalent assuming 35% rate
  • PIMCO Enhanced Short Maturity Strategy Fund (MINT): This actively-managed product is the closest thing to a money market ETF on the market. MINT invests primarily in short-term investment grade fixed income securities, including credit bonds, mortgage securities, and debt issued by U.S. agencies. Benchmarked against the Citigroup 3-Month Treasury Bill Index, this fund will generally maintain a duration of less than one year. For investors looking for a safe place to park assets temporarily, MINT might be a more appealing option than cash [see Five Safe Haven ETFs].
  • iShares Barclays MBS Bond Fund (MBB): This ETF invests in investment grade, fixed-rate mortgage-backed securities issued by agencies of the U.S. government, including Government National Mortgage Association (GNMA), Federal National Mortgage Association (FNMA), and Freddie Mac (FHLMC). Despite encountering some turbulence during the recent downturn, the underlying index has a positive annualized return over the last ten years. While mortgage-related securities may be perceived as risky, the holdings of MBB are rated “AAA,” which explains the lower yield for this fund [see 2010: Year Of The Bond ETF].
  • Market Vectors Pre-Refunded Municipal Bond ETF (PRB): Most investors looking for exposure to MUB, but there are a handful of more targeted options out there. PRB consists of pre-refunded municipal bonds, securities created when municipalities refinance existing debt, often to take advantage of lower interest rates. To accomplish this, “refunding” bonds are issued, and the proceeds are used to buy securities that are placed in escrow and dedicated to paying the interest and principal on the original issue. So pre-refunded bonds often carry very little risk; the tax-equivalent 30-day SEC yield is only about 20 basis points higher than that of MINT [see Wide World Of Muni Bond ETFs].
  • Vanguard Short-Term Corporate Bond ETF (VCSH): Most investors seeking exposure to corporate bonds gravitate towards LQD, which has total assets of about $15 billion. But for investors looking for more granularity and specific maturities, Vanguard offers some more targeted options, including VCSH, VCIT (intermediate-term), and VCLT (long-term). This fund offers exposure to investment grade corporate debt securities while minimizing interest rate sensitivity; the average duration for this fund is less than three years [also see Five Bond ETFs Worth A Closer Look].
  • PowerShares International Corporate Bond ETF (PICB): Most investors maintain little or no exposure to international fixed income securities, making this ETF a potentially interesting way to diversify holdings while also beefing up returns. PICB invests in investment grade corporate debt from non-U.S. issuers denominated in a handful of developed market currencies, including euro (49% of assets), and British pound (25%), and Japanese yen (9%). The heavy allocation to European firms may translate into additional risk relative to funds such as LQD, and this ETF offers additional compensation in return.
  • PIMCO Build America Bond Strategy ETF (BABZ): Build America Bonds, a creation of the American Recovery and Reinvestment Act of 2009, have proven to be incredibly popular with investors. Unlike traditional munis, these securities are taxable securities issued by local governments to give them access to conventional corporate debt markets. The Treasury Department makes a direct payment to the issuing municipality in an amount equal to 35% of the interest payment on Build America Bonds, thereby allowing issuers to offer debt that has an attractive coupon from an investor perspective but a reduced interest burden from the issuer perspective. This actively-managed fund is tilted towards the long end of the duration curve, a result of the relative novelty of this asset class [see All American ETF Options].
  • SPDR Barclays Capital Convertible Bond ETF (CWB): This ETF is another one-of-a-kind, offering exposure to bonds that can be exchanged, at the option of the bondholder, for shares of the issuer’s preferred stock. This feature gives these securities enhanced upside potential during bull markets while still providing the downside protection typically associated with fixed income. Investors will, of course, pay for the flexibility afforded by this security through a lower effective yield.
  • WisdomTree Emerging Markets Local Debt Fund (ELD): This ETF has been one of the most successful new products of 2010, as investors have embraced the opportunity to own debt offered by emerging market issuers that is denominated in the local currency. Although the balance sheets of emerging markets are often considerably stronger than those in the developed world, the perception of a “risk gap” remains–which translates into higher yields for ETFs in the Emerging Markets Bonds ETFdb Category. ELD offers a materially higher yield than funds focusing on U.S. Treasuries of the same duration, making it an interesting option for investors willing to go beyond the U.S. borders [read Emerging Markets ETF Boom Continues].
  • Vanguard Extended Duration Treasury ETF (EDV): This ETF maintains minimal credit risk–all of its holdings are rated Aaa–but features material interest rate risk thanks to one of the longest durations available. EDV has an average maturity of about 25 years and an average duration of more than 27 years. This ETF tracks the Barclays Capital U.S. Treasury STRIPS 20–30 Year Equal Par Bond Index, an index comprised of zero-coupon Treasuries with remaining maturities between 20 and 30 years.
  • PowerShares Fundamental High Yield Corporate Bond Portfolio (PHB): The rise of the ETF industry has prompted further evolution of indexing, resulting in a number of fundamentally-weighted benchmarks that many investors have embraced as more efficient investable assets than products that replicate market capitalization-weighted strategies. The index underlying this ETF determines individual holdings and weightings based not on size, but on book value, sales, dividends, and cash flow. That leads to a focus on higher quality junk bonds, giving PHB a risk/return profile that is unique from other products in the High Yield Bonds ETFdb Category [see PHB: A Different Kind Of Junk Bond ETF].
  • PowerShares CEF Income Composite (PCEF): This fund doesn’t fit perfectly into the bond ETF bucket, as its underlying holdings consist of closed-end funds that invest in taxable investment grade fixed-income securities, taxable high yield fixed-income securities and that utilize an equity option writing strategy. Although PCEF generally trades very close to its NAV, the underlying holdings can and often do exhibit discounts, adding another element to the risk profile of this fund. PCEF’s 30-day SEC yield currently stands around 8.1%, while the distribution yield of 8.4% is hard to find anywhere else.
  • Market Vectors High Yield Municipal Bond ETF (HYD): This fund is another more targeted option within the muni bond space, tracking an index that makes a 25% weighting to BBB rated muni bonds and 75% to securities rated below investment grade. Historically, high yield municipal bonds have exhibited lower default rates than comparable high-yield taxable securities, making this fund a potentially attractive option for yield hungry investors [see Beyond JNK: ETF Options Delivering Juicy Current Returns].

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Disclosure: No positions at time of writing.