Bond Exchange Traded Funds (ETFs): What Are They and Why Trade Them

ETFs are a type of pooled investment fund with a basket of multiple underlying assets. ETFs can be a way for traders to expose their portfolios to a diverse pool of stocks, bonds, and securities.

Typically, ETFs will be used to track a particular sector, commodity, or index, and will be traded on the stock exchange market just like a regular stock. In this article, we will look deeper into bond ETFs and why traders should trade them.

What are Bond ETFs and How Do They Work?

A bond is essentially a loan that the borrower issues to raise money from investors that are willing to lend them money for a certain amount of time ^[1]. For an investor, when they purchase a bond, they will receive payouts in the form of yields and ultimately need to wait till the bond matures to get back their principal amount. For example, a $10,000 bond with a 10-year maturity date and a coupon rate of 5% would pay $500 a year for a decade, after which the original $10,000 face value of the bond is paid back to the investor ^[2].

Corporations that are looking to grow their business can consider issuing bonds as they might need far more money than the bank can provide. Bonds provide a solution by allowing many individual investors to assume the role of the lender.

A bond ETF, like its name suggests, is an ETF that invests specifically in bonds only. Bond ETFs are traded on the stock exchange, and traders can apply their trading strategy just like how they would generally trade a stock. Typically, the bond ETFs are passively managed by a fund manager. However, there are some actively managed bond ETFs that try to beat a benchmark index as well.

Instead of being sold over the counter by bond brokers like individual bonds, bond ETFs trade continuously throughout the day on a centralised market. Only the biggest and most liquid bonds from the underlying bond index are often included in bond ETFs. This allows the bond ETF to mimic the index while still being more trader friendly at the same time ^[3].

Examples of such bonds include the Vanguard Total Bond Market ETF (BND) which tracks the performance of a broad, market-weighted bond index and Vanguard Total International Bond ETF (BNDX) which tracks the performance of the Bloomberg Global Aggregate ex-USD Float Adjusted RIC Capped Index ^[4,5].

Difference between Bond ETFs and Bonds 

	Bond ETFs	Bonds
Maturity	Maintain a constant maturity as some of the bonds in the ETFs may expire, and new bonds will be added and sold to keep the maturity an average constant.	Maintain a fixed maturity and regular date at which they would mature, and investors will get their money back upon maturity when the bond issuer must repay the original bond value to the bond holder.
Payments	As bonds ETFs hold many different bonds in the same portfolio, there are different bonds paying their coupon at different times. This results in bond ETFs having monthly interest payments to investors.	Depends on the specific bond coupon payments. The interest payments usually happen every six months [6].
Tradability	Bond ETFs are traded on a market exchange; thus, they can be bought and sold anytime during market hours. The ETFs can be traded through brokerages.	Some bond issues trades daily, while others are traded as little as once a month. Trading varies depending on the bonds. These bonds are usually traded over the counter market.

Difference between Bond ETFs and Bonds Mutual Funds

Bond ETFs and bond mutual funds are similar in terms of how they are represented. A fund manager will manage the funds collected from investors to buy a pool of stocks, individual securities and, in this case, bonds. Here are some differences that separates the bond ETFs and bonds mutual funds:

	Bond ETFs	Bond Mutual Funds
Expense ratio	Lower due to less management. The ETFs tend to track indexes, so trading activity can be less active.	Higher because actively managed. Actively managed, which will incur extra costs from the fund manager for doing research, analysis and trading.
Trading hours	Can be traded throughout the trading hours of the stock exchange market.	Can only be traded at the end of the trading day.
Minimum investment amount	Cost of one share of the ETF. For example, the BND ETF cost only $73.11 as of 19 September 2022 and traders only have to fork out that amount to get one share of the BND ETF.	Initial amount varies as set by the company or fund manager.

Types of Bonds ETFs 

There are various bond ETFs in the market, and it is divided mainly into four main categories: sovereign, corporate, municipals and broad market.

• Sovereign bond ETFs track the debt issued by the governments of sovereign nations.
• Corporate bond ETFs consist of bonds issued by companies to raise capital and finance their operations. 
• Municipal bond ETFs are a type of sovereign bond debt that is issued by a state, country, city or even a town within the US to finance municipal projects such as highways and schools.
• Broad market bond ETFs combine the sovereign, corporate and municipal debts into one specific bond ETF.

The broad market bond ETFs often act as core fixed-income exposure and it is the one that is most commonly purchased by retail investors.

Why trade Bond ETFs? 

Pros	Cons
Diversification: Owning a bond ETFs allows traders to diversify their portfolio with exposure to more than just a single bond.	No money back guarantee: As Bond ETFs do not mature, they do not offer the assurance of getting back your principal amount like how a normal bond can.
Monthly payments: Some bond ETFs such as the Global X SuperDividend ETF (SDIV) pay dividends monthly [7].	Expense ratio: Bond ETFs are generally preferred more than stocks due to their less volatile nature, however their potential returns can therefore also be limited. The potential returns will also be used to cover the management fees and this might further reduce the total returns.
No maturity dates: Bond ETFs do not mature as they consist of a range of different bonds with different maturity dates. This also makes it easier for traders to manage their portfolio.	Interest rates: When interest rates change, the value of the bonds may fall [8]. With individual bonds, traders lessen the risk by holding onto the bond till it matures. Bond ETFs don’t mature so there is little a trader can do to avoid this.
Liquidity: Bonds ETFs trade like stocks on the stock exchange, which can be bought and sold anytime throughout the trading day.

How to trade Bond ETFs

#1 Open a brokerage account

Find the brokerage account that would suit you to begin trading with CFDs. Compare the brokerage features and platforms. Different brokerage accounts offer different minimum deposits, transaction fees per trade and inactivity fees. Once you have decided on a brokerage, it is time to open an account to get you started on your trading.

#2 Choose the Bond ETFs CFDs

Once the account is up and running, begin researching and compare the bond ETFs that you are interested in trading. As there are so many bond ETFs out there, traders can use a set of criteria during their search such as credit risk, interest rate risk, the underlying index and the bond ETFs expense ratio ^[9]. 

#3 Fund the account and begin trading

Once you have selected the bond ETFs that you want to trade, fund the account and begin trading the CFDs on ETFs available on the market.

Conclusion

Bond ETFs can provide a lot of value for traders and provide a means to help diversify their portfolio. In addition, the bond ETFs can be traded anytime throughout the trading day and traders can use different trading strategies such as day trading, swing trading and short selling to trade.

Vantage has just launched ETFs for traders to trade using CFDs. Open an account with Vantage and start trading bond ETFs today.

References