How Safe are Bond ETFs?

It’s been an unusual year that has caused investors of all types to re-examine the old ways of thinking when it comes to their exchange traded funds (ETFs). Typically, bonds have been seen as “safe,” but some got burned in that thinking.

In fact, bonds of all types took their licks this year. Tara Seigel Bernard for The New York Times explains that even though the bond market did not take a 40% decline like the general stock market did, they did suffer losses. Treasuries remained the lone place to hide, and diversified bonds stuck it out, too.

The lesson here is that diversification is a key element to stave off as much loss as possible. ETFs offer instant diversification, while giving investors the kind of exposure to a range of bonds that would be costly if they were bought one by one.

Nevertheless, for the older investor, any loss in fixed income is unwelcome, and untimely, as “the return of principal is more important than the return on principal.” Conditions may worsen before they improve, so older investors should check that their bond investments are indeed what they thought they were.

Moreover, several advisers and bond experts recommended that investors maintain higher cash reserves than they might in more normal times.

A peek at some bond ETFs:

• Vanguard Long Term Bond Fund (BLV): up 10.8% year-to-date

• iShares Barclays Aggregate Bond (AGG): up 7.8% year-to-date

• SPDR Barclays Capital TIPS (IPE): up 0.7% year-to-date

Comments

[Elwood Blues:]

I got stopped out of AGG at the very bottom of that spike down in October. Lessons learned: during a period of high volatility like we went through, cash is king. Having a stop loss on a bond fund when the mkt seized up was not a smart move. Bond ETFs are less stable than bond mutual funds since the ETFs rely on the market makers, which have now proved they are unreliable.

2008 Dec 31 07:31 PM

[Thomas Smic...:]

Although there are pitfalls with Bond ETFs, I have found them to be quite useful unto themselves in a portfolio that is appropriately proportioned for individual circumstances. When used in conjunction with ETFs specializing in preferred shares, a satisfactory mix can be achieved in this rugged investment climate, at least for now. And, an attractive blended yield is captured with diversification.

One area I have not touched: muni's.

2008 Dec 31 10:20 PM

[bigmoney:]

that was an ugly down spike in Oct. Other than a bad stop out, is there any other disadvantages to bond ETFs? I don't imagine you can easily stop out of a bond mutual fund, so just the nature of the fund smooths over any transients.

2008 Dec 31 10:23 PM

[NOWHEREMAN:]

TAS: Muni CEFs used CDS and/or Auction Rate to enhance their yields. Because that mix is considered to be very risky currently, Federally Tax Free Muni CEFs like MAV and MHI have current yields above 10% payable monthly. But, it is highly unlikely that the Fed and Treasury will allow defaults on municipal bonds and the fallout which would follow, State Defaults.

Meanwhile on the Corporate side, the view going into 2009 was that the Bear was about to ravage Commercial Properties and some 36,000 retailers are expected to Fail. Will the Corporate Bond you chose be left unscated?

Of the two, Corporate Bonds and Muni CEFs, I prefer the Tax Free Muni sector. At least they have a safety net.

IMHO

Jan 01 12:35 PM

[Jake2:]

"The lesson here is that diversification is a key element to stave off as much loss as possible. ETFs offer instant diversification, while giving investors the kind of exposure to a range of bonds that would be costly if they were bought one by one."

Boring. How many times have you heard this said about any number of investment vehicles? The article has very little content and says nothing new or interesting.. Once in a while someone has to take a stand on something. Do not read.

Jan 04 01:29 AM

[donzelion:]

Other than increased liquidity, what advantage does AGG have over BND? Seems that for fixed income investments tracking similar indexes, the key would be to squeeze every last dollar out of fees...

Jan 10 04:48 AM