Bonds have been beaten in 2022, but the silver lining is that investors can revalue their holdings without fear of realizing large capital gains. Today I’m going to review three basic bond ETFs that provide broad and diversified exposure to the fixed income market at a reasonable cost. These ETFs are Morningstar analyst award winners, which means we expect these funds to outperform on a long-term risk-adjusted basis.
In 2022, market volatility served as a rallying cry for active managers, but active bond funds have struggled to outperform their passive counterparts year-to-date. For this reason, I’m leading with two passive ETFs that gain their edge by providing broad exposure to fixed income securities at a price floor. Next, I’ll look to an active ETF that consistently outperforms thanks to its flexibility, strong resources, and experienced managers.
3 excellent basic bond ETFs
These exchange-traded funds are rated gold or silver by Morningstar analysts.
- iShares Core Total USD Bond Market ETF (IUSB)
- Vanguard Total International Bond ETF (BNDX)
- Fidelity Total Bond ETF (FBND)
The first ETF on my list is the Gold-rated iShares Core Total USD Bond Market ETF, or IUSB. This strategy tracks the Bloomberg US Universal Index, which includes taxable fixed-rate US dollar-denominated bonds across the credit spectrum with at least one year to maturity. Bonds are market value weighted, which promotes low turnover and taps into the collective wisdom of the market as to the relative value of each bond.
The fund consists primarily of US Treasury bills, agency mortgage-backed securities and corporate bonds. This includes a small tranche of high yield debt totaling around 8% of the fund’s assets. This portfolio closely resembles the Bloomberg US Aggregate Bond Index, aside from its wad of junk bonds. Its duration and quality are slightly lower than those of Agg, but its slight tilt towards riskier bonds has paid off in the long term.
Diversification is a hallmark of IUSB’s portfolio with its 14,000 bonds in tow. This ETF takes Agg’s investment universe one step further and better reflects the full range of opportunities available to active managers. IUSB provides a solid foundation of US Treasuries and dollar-denominated corporate bonds and securitized debt securities at the lowest cost in its class, making it an excellent core option for the bond portion of portfolios investors.
Next on my list is the Vanguard Total International Bond ETF, or BNDX. This ETF takes the same cheap and diversified approach abroad as the IUSB. Its portfolio includes high quality bonds issued in currencies other than the US dollar with maturities greater than one year. Bonds are weighted by their market value.
Eligible bonds include government, government-related, corporate and securitized bonds from developed and emerging markets. Credit risk is inherent in the territory of corporate bonds and emerging market issuers, but this fund is not overexposed to either sector. Instead, the performance of this fund will be primarily influenced by interest rate risk and changes in the term structures of the Japanese, Eurozone and UK yield curves.
The fund uses forward contracts to hedge its currency risk, giving it more clean exposure to local bond yields. However, its performance will not match local market returns because forward exchange rates do not track spot rates. But hedged exposure to foreign bonds is a sensible approach because the performance of unhedged bonds can be dominated by changes in currency prices.
The best feature of the fund is its low commission. It charges 8 basis points per year, 37 basis points cheaper than the average toll charged by its peers.
The last ETF on my list is the gold-listed Fidelity Total Bond ETF, or FBND. This is an excellent active fund for investors to build their portfolio. This fund takes a flexible approach to portfolio construction, moving away from benchmarks when opportunities demand it. In addition to investing in the typical investment-grade corporate credit, mortgages, and U.S. Treasuries that make up Agg, portfolio managers can allocate up to 20% to lower-grade bonds, including high yield debt and emerging markets. Although this may lead to higher credit risk, the managers generally keep the duration of the fund within a third of a year of the Agg, which helps to keep the fund afloat when rates rise.
The fund made shrewd allocation calls for the strategy. It found itself slightly more exposed to credit risk than its competitors at the height of the pandemic in 2020, causing the fund to lag behind its peers. But the strategy increased its exposure to credit by taking advantage of the wave of new credit issuance that came to market after the pandemic slowed, while reducing its exposure to US Treasuries and mortgage-backed securities. of agencies. This put it in a position to outperform its average 2020 category counterpart overall.
This fund charges one of the lowest fees in its class by actively managed funds at 36 basis points. And the theme of diversification continues with this fund, which holds 2,000 bonds in its portfolio. This strategy has proven ability to recoup costs and more, and it deserves to be considered a core bond portfolio for all investors.
Watch “3 Great ETFs for Rocky Markets” by Bryan Armour.