When Wall Street was booming and key interest rates at the Federal Reserve were near zero, many investors were happily allocating 100% of their portfolio to stocks. And then, in 2022, extreme volatility sparked substantial (and in some cases, record-setting) losses across the bond market.
But bond funds remain a key part to any portfolio. \"We still think high-quality bonds play a pivotal role in portfolios as they have shown to be the best diversifier to equity risk,\" says Lawrence Gillum, fixed-income strategist at independent broker-dealer LPL Financial. \"And it's best to have that portfolio protection in place before it's needed.\"
The Vanguard Total Bond Market ETF (BND (opens in new tab), $71.93) is a massive fund that ranks as the largest dedicated bond ETF, as well as one of the 15 largest U.S.-listed ETFs of any flavor. It allows investors a simple and effective way to get exposure to the bond market.
BND offers broad exposure to the investment-grade U.S. bonds of all flavors, with more than 10,000 individual securities in the portfolio. The average duration of the bonds is about 6.5 years right now, making it an \"intermediate\" bond fund that is neither too short term in its focus, nor too long term.
About 67% of BND's portfolio right now is allocated to U.S. government bonds such as Treasury notes or \"agency\" mortgage debts backed by federally backed financers like Fannie Mae and Freddie Mac. There's also corporate debt in there that makes up about 26% of the portfolio, but it's limited to the most credit-worthy borrowers to reduce the risk profile of one of Wall Street's best bond ETFs.
Just keep in mind that the bias of this ETF, as with many corporate bond funds, is toward banking and finance firms that are raising capital to fund their operations. About 25% of the portfolio in this sector, followed by 16% in consumer staples stocks and another 12% in telecom. But when you compare these against other riskier sectors like tech, it's clear that the focus of LQD is on established and stable firms with a high likelihood of repaying their debts.
Of course, if you really don't mind the added risk of corporate bonds in pursuit of higher yields, then you may want to look at so-called \"junk\" bonds. These are obviously loans to companies that aren't as consistent or stable as their peers that are given investment-grade ranking by credit agencies.
The iShares iBoxx $ High Yield Corporate Bond ETF (HYG (opens in new tab), $74.17) is one of the best bond ETFs for junk bond investors, with a big market cap and strong liquidity. It also offers a generous yield that is more than four times the S&P 500 Index.
You'll be buying a portfolio of some 1,200 bonds via HYG, so it's not like one single default will sink you. But keep in mind that every one of these loans carries elevated risk, as they are extended to firms like casino operator Caesars Entertainment (CZR (opens in new tab)) or satellite TV provider DISH Network (DISH (opens in new tab)) instead of your tried-and-true blue chip stocks.
Another way to slice up the corporate bond market is to focus on \"duration\" to adjust your risk profile. This term refers to how long the loans have to come due. Generally speaking, longer duration bonds carry significantly higher risk because it's hard to predict what will happen over the next 10 or 20 years, while short-term loans of just a few years tend to be less risky. The Vanguard Short-Term Corporate Bond ETF (VCSH (opens in new tab), $75.18) is focused on that latter strategy.
VCSH is one of the best bond ETFs for this strategy, given its average duration of just 2.7 years across a portfolio of nearly 2,400 bonds. Furthermore, these are investment-grade loans to firms like aerospace giant Boeing (BA (opens in new tab)) and financial giant Bank of America (BAC (opens in new tab)). With no \"junk\" in the holdings and a very short time horizon, investors can have confidence in the stability of these assets.
Moving away from corporates, some investors seeking out the best bond ETFs may want the rock-solid nature of U.S. government securities to fall back on. If this is your strategy, then the iShares 20+ Year Treasury Bond ETF (TLT (opens in new tab), $100.97) is perhaps the most popular way to do that.
Debt-ceiling shenanigans by fair-weather fiscal conservatives aside, the American government is one of the most consistent borrowers on the planet and always makes good on its debts. But with an effective duration of 17.3 years or so across this bond fund's holdings, it is able to command a higher premium than short-term government loans because of the added uncertainty added by the time element.
There is, of course, more chance of interest rate changes disrupting this fund along that timeline. But with a yield that is more than double that of the S&P 500 right now and a heck of a lot more certainty behind its holdings, TLT has a lot to offer fixed income investors.
If you really want to be low risk with your fixed-income portfolio, then look to the iShares 1-3 Year Treasury Bond ETF (SHY (opens in new tab), $80.94). This is a fund that, similar to the previous one, is backed by the U.S. government. However, SHY is focused instead on very short-term bond offerings to add even more certainty.
What's strange, however, is that right now SHY currently offers a better payday than its peers with longer duration Treasury bonds. That's because of the inverted yield curve at present thanks to our unique economic conditions, where investors are predicting that long-term interest rates will still be historically low even if in the near future we are facing higher rates as a result of Federal Reserve policies.
And even if yields do abate and if and when the yield curve normalizes, a fund like this is as much about capital preservation as it is about generating a regular payday. Over the long term, SHY sees much less volatility than stocks and is more stable than other varieties of bond funds, too.
If you can't decide how to balance yield and risk across these different flavors of bonds, or if you're simply not interested in the headache of deciding and managing that mix, consider the iShares Core Total USD Bond Market ETF (IUSB (opens in new tab), $45.03).
The foundation of the IUSB fund is investment-grade government debt including Treasury notes, which makes up about 35% of the portfolio. But there's also 23% in mortgage-backed securities, about 19% in industrial corporates and a handful of junk bonds and emerging market debt sprinkled over that.
So far, we've really only discussed the domestic bond market. But if you're interested in looking beyond just U.S. corporate and government debt, then consider the Vanguard Total International Bond ETF (BNDX (opens in new tab), $47.89). As the name implies, it allows for a global approach to the fixed-income marketplace.
This top bond ETF layers in investment-grade bonds from all over the world. From foreign governments to overseas banks and telecom stocks, you'll get a wide array of issuers across the more than 6,700 holdings.
If you're looking for a long-term bond holding, BNDX is worth a look. But be aware that this is every other market except the U.S., so you might want to own one of the prior funds, as well, to give yourself a holistic approach to the bond market.
Top regions among issuers include Japan (15%), France (12%) and Germany (10%). But keep in mind that because of the very low-risk profile of BNDX's holdings and the fact that rates in Europe and Japan are much lower in general than in the U.S., bond investors don't get paid much.
That's what makes the PIMCO Active Bond ETF (BOND (opens in new tab), $91.32) our final and perhaps our most interesting pick on this list of the best bond ETFs. It's not a vanilla index fund, passively linked to a fixed list of securities, but instead is an actively managed and tactical investment that changes allocations based on the opportunities PIMCO sees.
The fund owns about 1,100 different bonds at present with an average maturity of 9.2 years. They are mostly in the U.S., but also include a few international offerings. These are mostly investment grade, with 50% of assets in rock-solid AAA-rated bonds, but there's also 20% of assets in BBB bonds that are right on the cusp of \"junk\" status. And these are mostly (38%) in mortgage-backed securities, followed by about 29% in corporates.
You'll pay the highest expense ratio on this list for the complexity of this well-rounded and active fund. But if you want to just \"set it and forget it\" in a single bond holding, you could do worse than this PIMCO ETF.
Yields on high-grade corporate bonds appear compelling. However, from a credit-spread perspective, we see too little compensation above risk-free Treasuries given the late-cycle risks in the market.Spreads do have room to widen, but a renewed investor appetite for higher-quality bonds may put a ceiling on how wide spreads could drift.
We expect tighter financial conditions to crimp corporate finances broadly. Rising stars (company upgrades from high yield to investment grade) outpaced fallen angels (downgrades from investment grade) by a wide margin over the past two years. Still, we expect more downgrades in 2023, especially in lower-quality cyclical segments. The depth and duration of any market downturn would determine the impact, but we see that most companies are prepared for a normal recession.Within a more modest allocation to investment grade, we see value in higher-quality issues within financials, utilities, and noncyclical industries. We prefer noncyclical companies because they tend to retain earnings resilience during economic downturns. Though bonds of cyclical companies can have higher spreads at challenging times, they currently trade in line with noncyclicals, another reason we see noncyclicals as the better bet. 59ce067264