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US government bonds may be the most plentiful and frequently traded debt securities in the world but until recently they were devilishly difficult to get your hands on. Now a slew of new exchange-traded bond funds from Barclays Global Investors could be a boon for investors looking for low-cost, user-friendly access to the biggest bond market in existence.
BGI launched its first bond ETFs in 2002 and 2003, with three funds tracking Treasuries of varying maturities, one linked to Treasury inflation-protected securities, as well as a fund tracking investment-grade corporate bonds and another following a broad investment-grade bond index.
The funds – dubbed “iShares” – proved so popular that last month, BGI launched another eight ETFs at once, investing in different parts of the Treasury and investment-grade corporate debt market. It now has 14 bond ETFs in its iShares line-up, with two more in the pipeline.
Investing in fixed-income securities can be complicated. This is because the vast majority of the $4,000bn of Treasury bonds, notes and bills outstanding are held and traded by big institutions rather than individual investors. Much the same is true in the $5,000bn market for US corporate bonds.
As a result, building a diversified portfolio of bonds that incorporates a range of styles and maturities is tricky and expensive. That is, unless you are prepared to pay an institution to do it for you – by investing in a mutual fund, for example.
Exchange-traded bond funds are designed to get around these problems by providing a low-cost way to own a share in a ready-made bond portfolio that tracks a specific benchmark index. Put simply, ETFs resemble index-tracking mutual funds but instead trade on ex-changes like stocks. This means investors can gain exposure to a given sector with one trade and no minimum investment.
Matt Tucker, head of US fixed income solutions at BGI, says: “The product is a lot about taking an institutional quality platform and helping to bring it down to the retail level.”
He says investors who are trying to build a fixed-income portfolio with individual securities transactions can face prohibitive costs and a lack of price transparency.
“If an individual goes through a brokerage ac-count, they can pay between 50-100 basis points to trade a US Treasury security, and much of that cost can be hidden from view,” he says. “But if BGI does the same transaction for an iShares fund, we as an institution can trade for a fraction of that cost.”
ETFs are also a cheaper alternative to investing in fixed-income mutual funds, which have an average annual expense ratio of more than 1 per cent, according to Morningstar, a fund research provider. By comparison, BGI’s iShares funds have annual expense ratios of between 0.15 per cent and 0.20 per cent.
Meanwhile, investors in bond ETFs enjoy the liquidity and transparency of the equity markets for their fixed-income investments – BGI’s iShares are traded on the New York Stock Exchange.
Leo Kranefuss, chief executive of BGI’s ETF business, says this helps to “clear the opaqueness of fixed-income investing that some investors experience. Investors see for the first time intra-day pricing of groups of bonds that have similar maturities or quality.”
Tucker says BGI’s new expanded mix of bond ETFs is designed to meet the needs of the novice and the more experienced investor.
By providing the building blocks to create customised portfolios, investors can take views on the performance of different maturities, blended portfolios of government and corporate debt of varying quality, as well as the outlook for inflation.
“The idea is to provide one-stop shopping for the investor who wants diversified exposure present in a broad benchmark, and also allow the more sophisticated investor to customise exposures to meet their risk and return targets,” Tucker says.
Indeed, some of BGI’s bond ETFs have proved so popular that institutional investors are using them. The iShares Lehman Aggregate Bond Fund, for example, which tracks a broad investment-grade bond in-dex, last month had a single trade for $100m – almost certainly an institutional transaction.
Tucker says iShares hopes soon to offer more fixed-income products. “We’ve had a lot of interest from investors for ETFs backed by mortgages, municipal bonds, international and high-yield bonds,” he says. BGI has already filed with the Securities and Exchange Commission to launch an ETF tracking US mortgage debt, and another based on US high-yield corporate bonds.
Bond products such as BGI’s iShares remain a small part of the ETF industry. BGI counted $20bn in assets across bond ETFs industrywide, or 5 per cent of overall ETF assets under management at the end of last year.
But as the baby boomer generation approaches re-tirement age and looks for income-yielding investments, BGI expects demand to escalate for bond ETFs.
The good news for investors is that competition is heating up. Mutual fund giant Vanguard Group filed for its first set of bond ETF products last month.