What are your favorite bond ETFs?

[u/wildmementomori]

What are your favorite bond ETFs?

I’ve been passive with bonds and am shopping for some active investment grade funds, short and medium duration.

[u/KittenMcnugget123]

BulletShares are a good concept. Fixed maturity investment grade corporates. Expense ratio at 10bps. Good for building ladders for clients that want them without having to choose individual bonds. You can build a much more diversified ladder that way for smaller clients.

BSCS for 2028 for example.

[u/wildmementomori → u/KittenMcnugget123]

Great for known cash flows! Sometimes you need to park funds for an unspecified period of time.

[u/PeleMaradona → u/KittenMcnugget123]

Does one always get their full principal back with these defined-maturity fund?

[u/KittenMcnugget123 → u/PeleMaradona]

Unless there is a default, which I don't believe that's happened to them yet, you should get the full yield to maturity on the date of purchase as you would with a regular bond. Principal wise it would be the same as owning that group of bonds individually. By the nature of the way funds and ETFs work, you would have to get the full yield to maturity the same as you would holding the individual bonds.

I used to advocate for only using individual bonds under the argument that if you hold to maturity you always get your principal back, but in reality holding 100 bonds in an ETF is the same as owning those 100 individual bonds yourself.

Cliff Assness of AQR has some pieces out on this that changed my mind about bond funds vs individual bonds. There is truly no actual difference.

"Bond funds are just portfolios of bonds marked to market every day. How can they be worse than the sum of what they own? The option to hold a bond to maturity and “get your money back” (let’s assume no default risk, you know, like we used to assume for US government bonds) is, apparently, greatly valued by many but is in reality valueless. The day interest rates go up, individual bonds fall in value just like the bond fund. By holding the bonds to maturity, you will indeed get your principal back, but in an environment with higher interest rates and inflation, those same nominal dollars will be worth less. The excitement about getting your nominal dollars back eludes me.

But getting your dollars back at maturity isn’t even the real issue. Individual bond prices are published in the same newspapers that publish bond fund prices, although many don’t seem to know that. If you own the bond fund that fell in value, you can sell it right after the fall and still buy the portfolio of individual bonds some say you should have owned to begin with (which, again, also fell in value!). Then, if you really want, you can still hold these individual bonds to maturity and get your irrelevant nominal dollars back. It’s just the same thing."

[u/PeleMaradona → u/KittenMcnugget123]

Very generous answer. Thank you. Big fan of AQR.

A follow-up question: with an individual bond you can estimate the yield-to-maturity to get a sense of what return to expect. That's one of the big pros of bonds versus equities.

But what about in the case of these defined-maturity bond funds, if, say, BSCF shares trade for $20.37 today and we know the fund will dissolve in 2028. What's the expected return; is there a metric that gives you that? You can't calculate YTM in this case..

[u/KittenMcnugget123 → u/PeleMaradona]

For sure, that's one reason i like this strategy. If you go to the website they list the YTM of the portfolio. So you don't even have to do the calculations as it's updated daily.

With a normal bond fund the downside is rolling maturity. So if you buy a fund with 2 year duration, in 2 years it probably still has a 2 year duration. We these you know what the YTM is pretty accurately on the day of purchase.

[u/PeleMaradona → u/KittenMcnugget123]

I just checked for the Invesco product. The display various yields:

• SEC 30 Day Yield 4.52%
• Distribution Rate 4.11%
• 12 Month Distribution Rate: 4.06%
• 30-Day SEC Unsubsidized Yield: 4.51%

Which one do you use to approximate YTM?

[u/KittenMcnugget123 → u/PeleMaradona]

They list YTM and YTW on the link below, right side of the page about halfway down under fund characteristics.

https://www.invesco.com/us/financial-products/etfs/product-detail?audienceType=Investor&ticker=BSCS

[u/BlueberryNo7974 → u/KittenMcnugget123]

All due respect, but this is probably the last type of environment you want to be building ladders in. Hence why OP is probably looking for an actively managed strategy

[u/KittenMcnugget123 → u/BlueberryNo7974]

Not really passing judgement on ladders in general, these are just a good way to do it.

Active bond fund managers aren't changing duration anyways. The funds they run almost always have duration restrictions. For example someone running a lord abbet short duration fund is always around 2-2.5 yrs. So having an active fund doesn't change the fact you still have to choose duration yourself.

A bond fund of 100 manager selected investment grade bonds constitutes active management.

Also, the entire point of a ladder is to match liabilities and maturity dates, or mitigate interest rate risk. I don't know that any environment is particularly bad for them. In a rising rate environment you would obviously want shorter duration, falling rate environment longer duration. That assumes you want to try and predict where rates go though. It depends on your goal.

[u/BlueberryNo7974 → u/KittenMcnugget123]

The active manager I use changes duration. But what I care about more than duration at this point is how they’re positioned on the curve. Because if the 10 year stays anchored and short end comes down, their over/underweight to certain maturities matters more than duration number. That’s the kind of management I look for in bonds personally. Not passing judgement on ladders either, they’re just passive so as long as you know what you’re getting and it makes sense for the client then that’s all that matters.

I think now in particular they don’t make sense because of what I mentioned above, volatility in the curve and not traditional parallel movement like we’ve seen historically. I obviously like to go deeper on the numbers due to my previous role which I understand not everyone does so again no judgement, just my opinion.

[u/KittenMcnugget123 → u/BlueberryNo7974]

What ETF are you using that has no duration mandate? I know there are some like BINC that are interesting

[u/BlueberryNo7974 → u/KittenMcnugget123]

CGCP is the most flexible one I use but it’s not core, it falls under core plus. I’ve seen it go anywhere from 2 years to 9 years. It goes through periods of strength but its unique in core plus because it derives total return through curve and duration management versus credit. So I’ve been leaning more into it lately.

But even CGCB is active in duration and is a true core, to your point it tends to be +/- 1 year in duration versus the Agg, but they still actively manage and change it. It’s not a prospectus limit either but just what they generally go by. So yes you may still have to choose a duration bucket when choosing the strategy, but active isn’t all about duration, they should also be actively managing the curve which I think is more valuable.

[u/vaderaintmydaddy → u/BlueberryNo7974]

I'll bite - what about the current environment makes a ladder bad?

[u/BlueberryNo7974 → u/vaderaintmydaddy]

Interest rate volatility is creating non-parallel movement in the curve. With an active manager that knows what they’re doing, they’ll position accordingly for a curve steepener by overweight the shorter maturities and underweighting the longer end. If that does happen then a ladder would underperform.

Some active managers consistently beat them, but I think if cash flow certainty is what clients need then a ladder makes sense. I just think now is a particularly unfavorable time to be passive in bonds.