ETFs have changed the way investors gain exposure to different classes of securities, and bonds are no different. Thanks to bond ETFs, investors can now build diverse fixed income portfolios by purchasing only a handful of products. But like so many asset classes, there are hundreds of bond ETFs divided up into all kinds of categories. Which type of bond ETF is best for your portfolio?
Quick Look: The Best Bond ETFs of This Year
- Best Overall Fund: Vanguard Total Bond Market ETF (BND)
- Best Fund for Low Fees: Schwab U.S. Bond Aggregate ETF (SCHZ)
- Best International Fund: Vanguard Total International Bond Market ETF (BNDX)
- Best Municipal Bond Fund: Nuveen S&P High Yield Municipal Bond ETF (HYMB)
- Best Corporate Bond Fund: iShares Broad USD Investment Grade Corporate Bond ETF (USIG)
- Best Fund for Inflation Protection: Schwab U.S. TIPS ETF (SCHP)
Table of contents [Hide]
- What are Bond ETFs?
- Pros and Cons of Bond ETFs
- The Best Bond ETFs
- 1. Best Overall Fund: Vanguard Total Bond Market ETF (BND)
- 2. Best Fund for Low Fees: Schwab U.S. Bond Aggregate ETF (SCHZ)
- 3. Best International Fund: Vanguard Total International Bond Market ETF (BNDX)
- 4. Best Municipal Bond Fund: Nuveen S&P High Yield Municipal Bond ETF (HYMB)
- 5. Best Corporate Bond Fund: iShares Broad USD Investment Grade Corporate Bond ETF (USIG)
- 6. Best Fund for Inflation Protection: Schwab U.S. TIPS ETF (SCHP)
- Final Thoughts
What are Bond ETFs?
While not as flashy or exciting as stocks, bond ETFs can guide investors toward a (somewhat) safe, steady return. Bonds are fixed income securities that function in the same manner as loans. Bonds are one of the primary ways business and governments raise money for their activities.
For example, let’s say Microsoft wants to raise $2 million for a new project. They could issue $2 million worth of new equity, but that would dilute the current value of the company’s shares. So instead, they issue 1,000 different 5-year bonds with a $2000 value and a 4% coupon. Investors lend money to Microsoft by buying the bonds and in exchange, they get their principal back in five years, plus the interest payments from the coupon.
Bond ETFs combine hundreds or even thousands of bonds into one financial product that can be traded on exchanges like a stock. It’s a convenient and efficient way for investors to add bonds to their portfolio, without the hassle of buying the actual bonds themselves.
Pros and Cons of Bond ETFs
Pros of Bond ETFs
Easier to trade: Bonds don’t get the same attention as stocks because they’re not as exciting plus, they’re illiquid. Most bond buyers aren’t looking to buy and sell on the open market; they simply want to buy bonds and hold them to maturity. Bond ETFs provide liquidity that the underlying bonds themselves cannot.
Safer than equities: Historically, bonds have returned less than equities but that smaller return is buffered by a level of safety. As long as the underlying company or government remains solvent, bonds won’t default. Additionally, bondholders are paid before shareholders if a liquidation occurs.
Monthly payments: Bond ETFs often have thousands of underlying bonds attached to them, so it’s impossible to pay out every time one reaches a coupon date. Instead, investors get a monthly interest payment, which can vary depending on how many underlying bonds paid out a coupon in the last month.
Cons of Bond ETFs
Hard to calculate: Bond ETF prices depend on a number of factors and because the fund constantly buys and sells underlying bonds, there’s no set maturity date to reach. Bond ETFs have greater transparency than bonds themselves, but the price calculation remains more difficult.
Too much optimization: Bond ETFs can only buy the best and most liquid bonds in an index, so the fund must choose which ones to own, a process called “optimization.” The results are good most of the time, but bond ETFs can steer away from the true index with improper optimization.
Returns usually lower than equities: One of the downfalls of bonds traded on exchanges is watching stocks shoot up on a green day while bonds remain unchanged (or worse). Bonds have traditionally been less risky, but the high-risk nature of stocks usually promises higher returns.
The Best Bond ETFs
Using the criteria mentioned below, Benzinga selected the six best bond ETFs across a wide range of fixed income securities. If you’re thinking of adding bond ETFs to your portfolio, you’ll want one that matches your investment style.
- Low fees
- Easy to trade
- Underlined with investment grade securities
- Tracks benchmark closely
1. Best Overall Fund: Vanguard Total Bond Market ETF (BND)
If you’ve been reading Benzinga for a while, it should come as no surprise that a Vanguard fund takes the top spot in an ETF category.
The Total Bond Market ETF invests 90% of its assets in the US fixed income securities with a few issues in Canada, Japan, Mexico, and Europe. Like all Vanguard funds, the 0.05% expense ratio is one of the best in the business.On average, more than two million shares are traded each day, providing investors with plenty of liquidity. The fund uses the Bloomberg Barclays U.S. Aggregate Float Adjusted Index as a benchmark and holds nearly 40% of its assets in U.S. Treasuries, with another 21% in mortgage-backed securities.
As of October 2018, the fund held 8,601 bonds with an average length to maturity of 6 years. BND is a great fund for if you’re looking to add broad U.S. bond exposure to your portfolio at a very fair cost.
2. Best Fund for Low Fees: Schwab U.S. Bond Aggregate ETF (SCHZ)
Vanguard has long been the king of the low-cost ETF, but Charles Schwab and Fidelity are aggressively trying to take that crown.
The Schwab U.S. Bond Aggregate ETF tracks the same benchmark as the Vanguard Total Bond Market ETF, but beats them with 0.04% expense ratio. This fund gives less weight to US Treasuries (38%) and more to mortgage-backed securities (27%), but the yield to maturity of 3.15% is right in line with Vanguard’s competing funds.
So why does the Schwab U.S. Bond Aggregate ETF not take the top overall spot? Short answer: liquidity. BND has over $35 billion in assets and trades over two million shares per day on average. SCHZ simply can’t compare to that with only $5.35 billion in assets and just over 500,000 shares traded daily. If you plan on buying and holding for a long time period, SCHZ is a good choice to make over BND, but active traders should stick with BND.
3. Best International Fund: Vanguard Total International Bond Market ETF (BNDX)
Surprise, surprise, another Vanguard fund! The Total International Bond Market ETF seeks to give investors exposure to international bonds denominated in non-U.S. currencies.
Getting liquidity in international bond markets can be tricky, but this fund is both low-cost and easily traded with 84% of the underlying securities rated A or higher. The 0.11% expense ratio gives the fund a cost advantage over most of its peers. The iShares competitor IAGG does have a lower expense ratio (0.09%), but holds far fewer bonds overall, making it very susceptible to tracking mistakes.
The Vanguard Total International Bond Market ETF currently offers over 5,200 bonds with the highest concentrations in Japan, France, Germany, and Italy. Over 53% of the issues held are denominated in euros, along with 20% in yen and 8% in pound sterling.
Unlike most international bond funds, the BNDX is quite liquid and over one million shares are traded on average each day.
4. Best Municipal Bond Fund: Nuveen S&P High Yield Municipal Bond ETF (HYMB)
Municipal bonds are riskier than federal debt bonds because local governments have a much higher likelihood of going broke, but because of this, they offer significantly higher yields.
The SPDR Nuveen S&P High Yield Municipal Bond ETF gives investors exposure to state and territorial government debt in the United States. With an expense ratio of 0.35%, HYMB comes in as one of the most cost-effective securities in the municipal bond space. Munis are notoriously illiquid and difficult to trade, so an ETF with 100,000 traded per day is a breath of fresh air.
California, Illinois, New Jersey, Florida, and New York are the states comprising the fund’s top five holdings. Over 40% of the bonds held in the fund are 20 or more years from maturity, so keep that in mind when figuring out what bond exposure your portfolio needs.
5. Best Corporate Bond Fund: iShares Broad USD Investment Grade Corporate Bond ETF (USIG)
Governments are the only ones issuing bonds to the public and the iShares Broad USD Investment Grade Corporate Bond ETF seeks to give investors exposure to fixed income securities from America’s most reputable companies. With a 0.06% expense ratio and 440,000 shares traded daily, the fund is cheap and easily tradable. The ICE BofAML U.S. Corporate Index is the fund’s benchmark and 71% of the securities held are from U.S. companies.
The top holdings are securities from companies like Bank of America, JPMorgan Chase, AT&T, Citigroup, and Apple that will reach maturity in one to 10 years. All the securities in the fund have a credit rating of BBB or better, with 49% getting at least an A rating.
6. Best Fund for Inflation Protection: Schwab U.S. TIPS ETF (SCHP)
TIPS are treasury inflation protected securities, bonds issued by the U.S. government designed to rise with inflation to protect your purchasing power. TIPS are among the safest assets you can own, and now you don’t need to visit the U.S. Treasury website to buy them. The Schwab U.S. TIPS ETF‘s expense ratio of 0.05% is very attractive, as is the liquidity of 800,000 average shares traded daily. The fund tracks nearly identically to its benchmark, Bloomberg Barclays U.S. Treasury Inflation-Linked Bond Index, but yield (2.59%) isn’t as high as some other funds on this list. Currently, the fund holds 51 different U.S. Treasury securities and has $5.7 billion in assets.
If risk bothers you and low returns aren’t a dealbreaker, the purchasing power protection offered by SCHP makes it a great core holding.
Bonds don’t get the same fanfare as stocks, but the bond market is deep and ETFs are providing new ways for investors to get exposure to every corner of the fixed income market.
If you’re looking to add bonds to your portfolio, it’s simpler and more cost-effective to buy bond ETFs instead of purchasing individual bonds yourself and waiting for them to mature.