Introduction

Bond ETFs are investment vehicles that trade on an exchange and invest in a portfolio of bonds.

They aim to provide a fixed return to investors, derived from the interest payments on the bonds they hold.

Different exposures

Bonds can come in many forms but are broadly split into three categories including government bonds, corporate bonds and newer bond market indices that focus on innovative ideas such as emerging markets. 

Each type of bond offers exposure to different sectors, credit quality and duration. 

Fixed income ETFs comprise of a basket of bonds that reflect the composition of a specific index, meaning that investors can gain exposure to a wide range of bonds instead of purchasing individual securities. 

Bond indices are typically far broader than their equity equivalents and can track as many as 25,000 securities. 

To track bigger bond indices, ETFs can employ a sampling replication methodology where portfolio managers invest in a smaller number of bonds that best represent an index’s characteristics. 

Governments or corporations issue bonds. Government bonds are most closely associated with reliable but lower yields, however, yields can still vary between governments depending on their creditworthiness. 

Corporate issuers tend to be from more established companies. Corporate bonds are seen as generally more risky than government bonds, and the yield paid out is slightly higher. 

As government securities are seen as low risk, ETFs offering exposure to these types of bonds gain popularity when market volatility increases. 

Benefits of bond ETFs

While investing in one bond will mean that you receive a fixed payment roughly every six months, bond ETFs typically pay interest each month. 

Fixed income ETFs offer all the usual benefits of ETFs. These include spreading their risk across a wide array of debt with a single transaction and reducing the impact of any single bond's performance on the overall portfolio. 

Unlike individual bonds, which may be harder to sell quickly without taking a loss, fixed income ETFs can be bought and sold on stock exchanges throughout the trading day. 

Fixed income ETFs lose their value when interest rates rise. Therefore, investors will typically favour fixed income ETFs when they forecast a decrease in rates. 

Final word

Overall, fixed income ETFs combine the benefits of bonds – such as income generation and lower volatility – with the advantages of ETFs including liquidity, transparency and cost efficiency.