Bond ETFs are going big-time; too bad they can be so misunderstood.
Fixed income remains one of the fastest-growing parts of the ETF market. With some $230 billion in 246 ETFs, investors have voted with their feet, and for good reason: Bond ETFs provide liquid, easy-access, generally tax-efficient exposure to the bond market.
Still, I get emails. I get emails from folks who think they understand the ins and outs of bond indexing, but miss a few key points when choosing a bond ETF.
Here are my top three:
1: “My U.S. Bond Fund Is A U.S. Bond Fund”
This is probably the biggest misconception about bond indexes. You see most bond indexes—and thus the ETFs that track them—decide whether a particular bond belongs in a U.S. index based on currency. If you issued your Paraguayan meatpacking bond in U.S. dollars, well, it’s a U.S. bond!
You don’t have to hunt very far to find out how wrong this is. Let’s take the largest “U.S.” bond ETF, the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD | B-64). iShares’ website lists the exposure as “U.S. investment-grade corporate bonds” and doesn’t even bother with showing a country breakdown like you might see in an international stock fund. I’ll save you the click over to our analytics product; here’s the actual country-of-issuance breakdown:
Sure, 78 percent of your holdings in LQD are in fact from U.S. companies, but 7 percent is U.K. LQD isn’t doing anything wrong here; it’s just how bond index providers generally work.
It’s not just index providers though. Consider the Pimco Enhanced Short Maturity ETF (MINT | A), the largest actively managed ETF in the country. Holdings here change every day, so you’ll need to monitor the published holdings on the website. Like LQD, its mandate is U.S.-dollar-denominated debt. In this case, the portfolio, as of today, holds:
Again, there’s nothing amiss here, it’s just important to recognize that the bets being made in MINT aren’t all short-term U.S. paper—it’s Chinese and Mexican and Japanese paper too, but denominated in dollars.