You must have heard about ETFs and that they come varieties but out of all the ETFs available, bond ETFs offer the most apparent benefits from the exchange-traded funds. So let’s learn more about bond ETFs.
What Are Bond ETFs?
Although bond ETFs, just like the other ETFs, do make a correlating index or underlying investment product, they are not as simple as the others.
Since bonds are usually fixed-income assets and are not very liquid, 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 their pricing information is not traditionally transparent.
Bond ETFs on the other hand, 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.
The good thing though is that once these bond ETFs are designed, they work equivalent to the other regular ETFs and also track a correlating bond index or product, just like them.
How Do Bond ETFs Work?
While bond ETFs are infamous for being intermittent, they greatly need to be liquid in order to be traded on exchange floors.
However, there’s a solution to this problem too. And that is if an ETF consists of only the largest and the most liquid bonds in the underlying bond index, making them more investment-friendly.
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.
All that said, 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.
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.