5 Top Bond ETFs To Navigate Tricky Markets

Bonds have long been considered a safe-haven compared with other asset classes. But with an interest rate rise on the horizon, investors are facing the mounting risk of bond prices collapsing.

Although parts of the fixed income spectrum remain relatively attractive, investors have the added burden of choosing how best to gain access to bonds. While some investors flag the limitations of indexing in the fixed income space, others note the inherent diversification, liquidity and low cost benefits of using ETFs.

Ben Willis, head of research at Whitechurch Securities, tips the £690.2 million iShares £ Corporate Bond 1-5yr UCITS ETF (ticker IS15).

“Managing the bond conundrum within our investment portfolios has been a key issue for some time, especially as we move ever closer to a rising interest rate environment,” he said. “However, bonds are still an integral asset class within a balanced investment portfolio. One way to mitigate the risk in rising interest rates is to invest in short dated corporate bonds.”

The iShares ETF offers exposure to the short-end of the investment grade universe. It is predominantly UK-focused, representing about 45 percent of the fund, but the index does provide meaningful exposure to Europe and the U.S. – roughly 25 percent and 15 percent respectively.

“The ETF’s ongoing charge of 0.20 percent is relatively expensive for the broad, core index it is replicating and it would be interesting to know if any monies made via stock-lending are used to bring that overall charge down,” Willis added.

The fund replicates the index using a “sampling” method, whereby it holds only a representative selection of the benchmark for liquidity purposes. It has returned 4.42 percent on an annualised basis over the past three years, compared with the benchmark’s 4.78 percent.

Kenneth Lamont, an analyst at Morningstar, highlights the Vanguard UK Government Bond UCITS ETF (VGOV), noting its low cost and efficient underlying index.

“A strong core holding for a UK centric portfolio, this fund invests in treasuries across the maturity spectrum,” he said.

“Although much smaller in assets under management terms than its iShares equivalent, this fund offers a lower management fee – 0.12 percent – and tracks a float-adjusted index, which in a post-quantitative easing environment provides a more realistic reflection of the underlying market.”

However, he warned that with a duration of around 10 years, this ETF can be expected to suffer when rates finally rise.

The fund, which holds £81.5 million, physically tracks the Barclays Global Aggregate U.K. Government Float Adjusted Bond index. The ETF has returned 3.06 percent over three years, gross of expenses, compared with the benchmark’s 3.04 percent.

Lamont also tips the SPDR Barclays Emerging Markets Local Bond UCITS ETF (EMDL).

“The search for higher yield vis-a-vis developed bond markets is the key selling point of emerging market government debt, with those denominated in local currency potentially boosting capital gains via foreign exchange,” he said.

“Investors have also been attracted to EM debt by virtue of its low correlation with traditional fixed income investments,” he added.

Lamont notes that although the ETF is slightly more expensive than the iShares equivalent, the fund offers broader country diversification and targets the most liquid bonds.

The fund, which has a total expense ratio of 0.55 percent and houses $1.3 billion of assets, was down -3.68 percent over the past three years, compared with the index’s -2.94 percent. The ETF holds a sample of bonds within the index for liquidity purposes.

Adam Laird, passive investment manager at Hargreaves Lansdown, recommends the SPDR Barclays 0-5 Year Sterling Corporate Bond UCITS ETF (SUKC).

He believes the fund’s exposure to short maturity corporate bonds makes it less vulnerable to an increase in interest rates, while the ETF has an attractive historic distribution yield of 2.5 percent.

The fund, which has a total expense ratio of 0.20 percent and assets under management of £74 million, tracks a sample of the underlying index, which comprises fixed-rate, investment-grade sterling-denominated bonds from industrial, utility and financial companies.

It has returned 3 percent over the past year, compared with the underlying index’s 3.28 percent.

Mr Laird also recommends the $321.6 million iShares Global High Yield Corp Bond UCITS ETF (HYLD), which costs 0.50 percent in annual fees.

“It’s been tough over the last year for high yield bonds – indices have fallen. This ETF has fallen around 5.5 percent so far this year,” he said.

“But it’s very possible that, even if rates begin to rise soon, it will take a long time to get back to levels of 2007. In the meantime, junk bonds will continue to provide higher interest payments – albeit with more risk.”