Looking For Income

[This article appears in our November 2019 issue of ETFR.]

It’s the year of the bond ETF … again.

As of the end of September, bond ETFs had already brought in $112 billion in new net investment assets, well outpacing flows into all other asset classes combined (see Figure 1).

It’s no secret why these funds have been so popular lately: Just open a newspaper (or Twitter) and scan the day’s headlines. Falling interest rates. Fears of recession. Political instability abroad and at home. All this uncertainty has sent ETF investors flooding toward the fixed income space, scrambling for whatever safety and yield they can find.

Most Popular Bond ETFs: Big, Cheap & High Duration
For the most part, investors have gravitated to large, proven funds, with strategies that they already know work.

The top 10 most popular bond ETFs of 2019 all share one thing in common: They’re enormous. Almost all of them already had over $10 billion in assets invested, before the year even began (see Figure 2).

Another unifying theme is low cost. All but one of the top-gaining ETFs costs 15 basis points or less; the only exception is the $18 billion iShares iBoxx USD High Yield Corporate Bond ETF (HYG). HYG costs 0.49% annually, but that long-term holding cost is less important to investors who largely use it as a short-term trading tool. (However, HYG also offers a compelling 5.87% yield right now, another possible reason investors have gravitated toward it as of late).

Finally, many of the top-flows-getting bond ETFs are long in duration; meaning, they’re highly sensitive to fluctuating interest rates. When interest rates fall, bond values tend to go up—more so for bonds with higher durations.

Indeed, the best-performing fixed income ETFs of 2019 have all been extremely long-duration funds; the best performer, the $339 million PIMCO 25+ Year Zero Coupon US Treasury Index Fund (ZROZ), which has risen 26.4%, also has the highest duration of any bond ETF, at 26.84 years (see Figure 3).

One Big Int’l Bond Fund
Looking at the individual funds, the bond ETF that has taken in the most money year to date is the $21 billion Vanguard Total International Bond ETF (BNDX), which tracks a broad-based portfolio of global, investment-grade debt. So far in 2019, BNDX has amassed a whopping $6.5 billion in net new assets.

Though the ETF includes some emerging names, the majority of BNDX is allocated to well-developed markets. More than half (56%) of BNDX is allocated to European bonds, while 21% of its portfolio is in Japan. That makes it a lower-risk diversification tool, as compared with funds with a higher emerging markets allocation, even though yields on many developed countries’ bonds are nearing multiyear lows.

Despite its popularity, however, BNDX is the only bond ETF in the top 10 with a global focus. In fact, the vast majority of bond ETFs that have seen significant year-to-date inflows are U.S.-centric (though, to be fair, the vast majority of bond ETFs are U.S.-centric, period).

The $4.3 billion First Trust Preferred Securities & Income ETF (FPE), a preferred securities ETF with a global selection universe, had the next highest inflows of international fixed income ETFs in 2019, bringing in $926 million.

BND & AGG Again Rake In Flows
Three other broad-based bond funds have also attracted assets, though their focus is on the U.S. market, not international: the $45 billion Vanguard Total Bond Market ETF (BND), the $66 billion iShares Core U.S. Aggregate Bond ETF (AGG) and the $14 billion iShares U.S. Treasury Bond ETF (GOVT).

BND has brought in $6.0 billion year to date, while AGG has brought in $5.1 billion. GOVT has added $6.4 billion in net investment flows.

BND and AGG are portfolio mainstays for U.S. fixed income exposure. Functionally, the two ETFs track the same benchmark: the Bloomberg Barclays U.S. Aggregate Bond Index, otherwise known as “the Agg” (though, technically, BND follows a float-adjusted version).

As such, the main distinguisher between these two funds is their total cost of ownership. With an expense ratio of 0.04%, BND is 1 basis point cheaper than AGG, which, over the long haul and in large lots, can make a difference. However, BND’s larger portfolio can be challenging to manage, leading to slightly higher volatility in tracking difference.

Ultimately, however, differences between these two massive (and massively liquid) funds are slight, and clearly, there’s room for both in the market.

GOVT, meanwhile, is a broad-based, fixed-rate Treasury ETF that holds Treasuries with remaining maturities of one year or more. That gives investors access to a wide swath of the domestic government debt market for the relatively low cost of 0.15%.

Narrower ETFs Have Broad Appeal
Also popular have been ETFs that cover narrower slices of the bond market.

The aforementioned TLT and the $17 billion iShares 7-10 Year Treasury Bond ETF (IEF) focus on Treasuries that fall within specific maturity ranges (20 years or more for TLT, and seven to 10 years for IEF). These have seen significant year-to-date inflows of $6.5 billion and $5.5 billion, respectively.

In the corporate space, the $25 billion Vanguard Intermediate-Term Corporate Bond ETF (VCIT) and the $25 billion Vanguard Short-Term Corporate Bond ETF (VCSH) have raked in $4.4 billion and $3.6 billion in net assets, respectively. VCIT has a maturity range between five and 10 years, while VCSH targets bonds with maturities between one and five years. 

Finally, the $19 billion iShares MBS ETF (MBB) has seen significant year-to-date inflows of $6.1 billion. MBB focuses on mortgage-backed securities, which historically have provided better yields than Treasuries over the same duration, while avoiding any of the credit risk of corporate bonds.

With these narrow-slice bond ETFs, investors and active managers can mix and match their funds to tweak their bond allocation’s yield and interest rate risk, allowing for more precise risk management than might be possible via a single, broad-based ETF.