If you are looking for income, diversification, and exposure to a specific asset class, bonds can play an important role in your investment portfolio. When looking at the bond universe, individual bonds, bond mutual funds, and bond exchange-traded funds (ETFs) offer ways to obtain the benefits of fixed income.
The latter of these investments has been popular; bond ETFs attracted $55 billion, $84 billion, $123 billion, and $98 billion in net flows the last 4 years, respectively.1
Here are a few key things to know about bond ETFs—and some ETFs to consider.
The big bond world
When it comes to the bond market, you have a lot of choices. It can be a daunting task to assemble and maintain an appropriately diversified portfolio of individual bonds, given the size and diversity of the more than $100 trillion bond universe.2
Buying bonds in the past was more complicated, as the bond market used to be more opaque and fragmented. Today, with visibility into recent trades, depth of available inventory, and access to most of the available secondary market offerings, you are able to get a better snapshot of a bond’s value and its liquidity than ever before.
In addition, bond mutual funds and bond ETFs are often a low-cost way to buy a diversified basket of bonds, even if you have a relatively small amount of money to invest. For a detailed comparison of the features of bonds, bond mutual funds, and bond ETFs, see the table.
Bond funds up close
While bond mutual funds have been around longer, bond ETFs are growing in popularity. Since the first US-listed bond ETF was launched in 2002, bond ETFs have accumulated over $652 billion in assets—although that is still a fraction of the roughly $3.8 trillion bond mutual fund market.3
Bond ETFs are similar to bond mutual funds in that both hold a basket of individual bonds and are professionally managed, either passively (the fund attempts to mirror the performance of a bond index or benchmark) or actively (the fund attempts to outperform a bond index or benchmark). To date, most bond ETFs are passively managed.
Both bond mutual funds and bond ETFs can provide exposure to a variety of markets, sectors, maturities, and credit qualities.
Their tax treatment is similar too. When it comes to individual bonds, you generally pay income taxes on interest received at ordinary income rates, unless the bond is tax-exempt, but you don’t pay capital gains taxes unless you sell the bond before maturity at a profit. With a bond ETF or fund, you will likely pay both income taxes on interest paid when you sell units of a fund, typically through a monthly dividend (e.g., a fund distribution), and capital gains if they are paid out, typically through an annual dividend (e.g., a fund distribution).
However, there are some differences. Whereas a bond mutual fund’s price is set at the end-of-day market price, a bond ETF is bought or sold at the intraday market price, which may be different than the ETF's net asset value (NAV).4
Bond mutual funds generally provide holdings disclosures monthly and discourage short-term trading of fund shares. In comparison, bond ETFs are required to disclose their holdings daily to support daily exchange trading activity. Depending on distribution models and to control short-term trading, bond mutual funds may be subject to redemption or transaction fees; bond ETFs are not. Instead, bond ETFs are subject to bid-ask spreads and brokerage commissions or fees.
“Bond ETFs might be most appropriate for those fixed income investors who like the advantages of ETFs, including intraday trading and holdings transparency,” explains Lee Sterne, ETF strategist with Fidelity. “Bond ETFs let you tactically pick and choose when you want to enter and exit the market, based on prevailing market conditions.”
Bond ETF risks
Of course, just as bond ETFs provide certain advantages, they also have risks. Bond ETFs have risks similar to individual bonds and bond mutual funds, such as maturity, interest rate, and credit risk. Bond ETFs also have tracking risk (a measure of risk that is due to active management decisions made by the portfolio manager), and their potential valuation may be at a premium or discount to NAV.
Additionally, some bond ETFs may not have a long enough track record to analyze how they might react to different market conditions and phases of the business cycle.
Abundance of bond ETF opportunities
You should decide for yourself whether bond ETFs, bond mutual funds, or individual bonds are right for you. Or a combination of these different types of products might be suitable, depending on your specific investing objectives, risk constraints, and time horizon. Whatever route you choose, a strong case for active bond management can be made in today's market, given the size and complexity of the bond universe.
If you are interested in exploring bond ETFs, check out the list of the largest bond ETFs by NAV within 8 bond fund categories. Additionally, Fidelity offers 5 other bond ETFs that are available for purchase on Fidelity.com commission-free: Fidelity Total Bond ETF (FBND), Fidelity Corporate Bond ETF (FCOR), Fidelity Limited Term Bond ETF (FLTB), Fidelity High Yield Factor ETF (FDHY), and Fidelity Low Duration Bond Factor ETF (FLDR).
Next steps to consider
Find bond ETFs and ETPs that match your investment objectives.
Learn what you need to know before trading the market.
Learn more about our active and factor fixed income ETFs.