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Bond ETFs – How Do They Work

Updated on :  

08 min read.

You must have heard about Exchange Traded Funds or ETFs and that they are of different types. Out of all the ETFs available, bond ETFs offer the most viability and benefits.

Bond Exchange Traded Funds or ETFs

Although bond ETFs, just like the other ETFs, make a correlating index or underlying investment product, they are not as simple as the others. Bonds are usually fixed-income assets and are not very liquid. Hence, investors hold these bonds until maturity and do not usually trade them on secondary markets like stocks and indexes.

Another important aspect about these bonds is that their pricing information is not traditionally transparent. This is where a bond ETF differ. Bond ETFs need to be liquid, and available to the secondary markets. Also, these cannot afford to have unclear pricing. These are a few areas that a bond ETF needs to overcome. A positive thing is that after structuring a bond ETF, they work just like any other ETFs. They also track a correlating bond index or product, just like them.

Who should invest in bond ETFs?

Bond ETFs are low risk investment avenue, just as most fixed income instruments. So, this suits people who are not seeking too much risk exposure. As the investment instrument is liquid in nature, it appeals to people savings towards short-term goals.

How bond ETFs work?

The bond ETFs that are typically managed passively and are traded exactly like the stock ETFs on a major exchange, the process keeps the market stable by enhancing liquidity and transparency during hard times. While bond ETFs are infamous for being intermittent, they greatly need to be liquid in order to be traded on exchange floors. But, there is a solution to this problem too. That is, if an ETF consists of only the largest and the most liquid bonds in the underlying bond index, it makes them more investment-friendly.

Why invest in bond ETFs

The bond ETF market is still in a nascent stage. In fact, some reports suggest that as of June 2015, this genre of ETFs held about $318 million in assets under management or less than 1% of the total market. So, even if bond ETFs were to see a downfall, the event would not impact the bond market at all. Also, unlike regular bonds where payments happen at fixed intervals, bond ETFs hold different maturity dates for the assets. Since these are expected to be due for a coupon payment at any given time, the bond ETFs pay interest every month with the value of the coupon changing from month to month.  

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