How to choose the Best US Bond ETF

HOW to choose the best US BOND ETF?

Annual Yield for key Bond ETFs vs. Expected Inflation

As of 15th July 2021. Current Yield to Maturity for different Bond ETF Categories and Time Horizons. Inflation is annualized over the period. The longer the horizon the higher the return. However, Intermediate High Yield is riskier than Long Term Investment Grade Corporate Bonds. Source: Bloomberg, Bankeronwheels.com

Key Selection Criteria

Depending on whether you are saving for retirement or have retired already certain Bond ETFs may be more suitable than others.

Treasuries stabilize your portfolio. Once retired, you may think of earning additional income from Corporates.

Bond ETFs should match your time horizon and fit into your wider portfolio.

#1 Be Smart about Yield

Before you dive deeper into the yields in the tables below, remember that:

  • Comparing yields can be tricky  each provider can have its own calculation methodology and there are numerous ways of defining yield. Fortunately, the tables below are consistent and sourced from Bloomberg giving you a fair comparison of the Funds.
  • All Yields to Maturity in this Guide are before inflation
  • The only exception are Inflation Protection Bond ETFs (TIPS) that have a yield in the table after inflation (i.e. Real Yields). Therefore, if you want to compare Treasury Bond ETFs with TIPS you need to subtract inflation from the Yield to Maturity. In real terms (Real Yields) returns from both of them will be similar
  • Municipal Bond ETFs may be exempt from certain taxes (e.g. Federal) hence the yield/dividends should be compared to yields post tax from other categories 

#2 Think about Inflation

Before any Bond ETF analysis below don’t forget to have a quick look at expected Inflation.

Always compare expected ETF Yield to (broadly) the same horizon of expected Inflation.

By subtracting inflation from the Nominal Yield in the below ETF tables, you will understand what is the real return you can expect accounting for changes in consumer prices.

E.g. For the Intermediate Bond Category, you can take Medium-Term Inflation etc.

Below are the current expected annual inflation rates for different investment horizons: 

#3 Choose between Cash and Bond ETFs

Certain bonds have currently negative real yield and you may be wondering – why bother at all? 

One option that is always on the table, before even considering the below funds is keeping your cash.

How much can I gain/lose by holding Bonds ETFs vs. Cash?

Or if rates rise, are Bond ETF losses temporary? If so, when will coupons offset any price losses for my Bond ETF?

I have a dedicated article with a Bond ETF Calculator that answers these questions and how to help you decide between Bond ETFs vs. Cash (or having both) in a low yield environment.

#4 Pick the Time Horizon

It is considered good practice to match your time horizon (Short Term, Intermediate or, Long term) with the appropriate Fund Maturity Profile.  

The Bond ETFs below are sorted by Term that you should match with your investment horizon:

  • Short Term Bond ETFs (up to 3-year duration)
  • Intermediate Bond ETFs (3 to 10-year duration)
  • Long Term Bond ETFs (usually with duration over 10 years)

#5 Evaluate Safety vs. Income Trade-off

Saving for Retirement or Decumulation

If you are in  an accumulation phase and saving for retirement and looking for Bonds to hedge your Equity portfolio the best choices are Aggregate Bond or Treasury Bond ETFs as well as TIPS.

Read more about how these Bond ETFs can work as part of a wider portfolio. 

If you are in a decumulation phase and have already retired, you may consider replacing some risk assets with some low risk income through Corporate Bond ETFs or may in some cases contemplate, depending on your risk tolerance, the rest of your portfolio, and tax situation some niche ETF markets like High Yield Bond ETFs or Munis.

Aggregate Bond Funds

Also called Core or Blended Bond ETFs. The first group is a broad category consisting of a mix of  Treasuries, High-Quality Corporates, and Mortgage Bonds, all usually rated Investment Grade. 

Importantly, these ETFs are the easiest to invest in since they include most of the high quality bond universe.

 

US Treasury Bond Funds

The second group consists of Treasury Bonds that are considered virtually risk-free (no Default Risk). However, yields are currently very low and after accounting for inflation even negative for short term / intermediate Bond ETFs.

 

High-Quality Corporate Bond Funds 

The third group consists of bonds called Investment grade bonds – considered relatively safe because the resources of the issuers are sufficient to indicate a good capacity to repay obligations (usually issued by Blue-Chip Companies)

When you review the below tables keep in mind that conceptually the higher the “Spread” the higher the Credit Risk (although Spreads tend to also increase with time horizon, more about this here

 

High Yield Bond Funds

The highest yielding bonds are also known as speculative. Importantly, all Corporate Bonds face Default Risk. However, Speculative-grade bonds are issued by companies perceived to have a lower level of credit quality compared to more highly rated investment-grade companies (Read More on Credit Ratings)

 

Inflation Protection ETFs and Municipal Bond ETFs

Inflation Protection Treasury Bond ETFs (also known as TIPS) and Municipal Bond ETFs (also known as Muni ETFs) have their specific characteristics.

Inflation Protection ETFs are as safe as Treasuries and will generate Real Rates of return (which are currently negative) but protect you should inflation pick up (the yield is the sum of the one you see in the table below and inflation since their cash flows are adjusted for inflation).

Municipal Bonds are financing local governments and may have higher Yield than Treasuries (but also more risk) and potentially preferential Tax treatments.
 

#6 Consider Size

Why is the size of an ETF important?

If you have invested in ETFs you may have witnessed closure of a Fund because commercially it wasn’t profitable. It’s not a problem for liquid markets but Bonds typically aren’t and small funds:

  • Are linked with the risk of closing down
  • When they close down there is a risk the liquidation won’t be executed at the best prices

Note that most of the ETFs below have a minimum size anyway and are considered benchmarks by market participants (I’ve not considered ETFs below $1bn AUM with a couple of exceptions)

Largest Funds in each category

#7 Understand Bond Risk and Return

Bond ETF Calculator Run your scenario in JPOW Calc and test how rising rates may affect your Government Bond (and to a great extent Aggregate Bond) ETF

  • Assets are a measure of the Size of the Index Fund Fund. I generally only list Index funds with a minimum size of $1bn that are widely used by Investment Professionals. The exceptions are Niche Funds (Category 4) which are smaller by definition
  • Expense Ratio – keep it low to generate more return. In order to do that plug two expense ratio numbers for comparison in the ETF Fee Calculator to see how it impacts your returns over the long term
  • Duration is a measure of Interest Risk for Bonds (more on Interest Rate Risk). 
    A rule of thumb is to align the average maturity of a bond ETF with the length of time that you’ll have your money invested in that ETF. Also, that the longer the duration the more you can gain or lose from moving interest rates (for Treasuries, it will also provide a more effective diversification for Equities since rates tend to fall in a downturn)
  • Spread is a measure of Credit Risk for Corporate Bonds (more on Credit Risk). Broadly speaking it is the additional return (in basis points 100 bps = 1%) over US Treasuries. Therefore, the higher it is the riskier the Bonds
  • Yield to Maturity – is what you can expect the Bond ETF to generate going forward (conceptually it is the sum of  Treasury Bond Yield and Spread) but before taking into account inflation
  • Dividend Yield – shows how much was generated over the past 12 months. It can also include Capital Gain. However, past dividend yield is not necessairly an indication of future dividends (Example for Treasuries described here)
  • Year to Date Return – Bond ETF price move year to date. Moves in an opposite way to changes in interest rates and spread
  • Maximum Drawdown – is the maximum historical Bond ETF price decline from the peak. As you can see it is in line with a combination of either or both duration / spread that are the key risk metrics for Bonds. However, this should not be seen in isolation but rather how the drawdowns behave combined in a portfolio with Equities

BEST BOND ETF SELECTION

AGGREGATE BOND ETFS

Best Bond ETFs by Relative Size

One of the Best Bond ETFs is iShares Core Total USD Bond Market ETF (IUSB)

  • The fund is fairly safe with 65% of Bonds in the highest rating category (AAA)
  • The ETF is generating one of the highest yields in its category in this low yield environment 
  • Outside of Government Bonds and Mortgage-backed Securities from government-backed entities like Fannie Mae and Freddie Mac the incremental Yield comes from a handful of Financial Institutions like Morgan Stanley, or Industrials like Oracle, Verizon or Dell
  • This ETF should provide a good diversification for your Equity portfolio while still generating yield

Aggregate Bond ETF Category - Best Bond ETF List

Below are some of the Best Fixed Income ETFs in 2021 as regarded by Market Participants in Category “Aggregate Bond ETFs”:

Aggregate Category - Best Bond ETFs Links

TREASURY BOND ETFS

Best Treasury Bond ETFs - Relative Size

One of the Best Bond ETFs is iShares US Treasury Bond ETF (GOVT)
  • Firstly, this fund provides the best Yield in the Intermediate category
  • Secondly, Treasuries are the safest investment that benefits from flight to quality should the market deteriorate (yes, yields can go even lower from here which would boost this fund)
  • However, after accounting for Inflation like most of the below Funds, GOVT ETF yields negative Real Return e.g. Annual Yield is 1.5% while 7 Year Inflation Rate is 2.5%
  • Also, there is also a risk of under-performance should Inflation come back
  • In conclusion, this is why I marginally prefer the Aggregate Funds (Category #1) 
 

Read more about risks and returns you can expect from US Treasury Bonds in 2020

Treasury Bond ETF Category - Best Bond ETF List​

Below are some of the Best Fixed Income Index Funds in 2020 as regarded by Market Participants in Category “Treasury Bond ETFs”:

Click to enlarge

Treasuries - Best Bond ETFs Links​

CORPORATE BOND ETFS

Best Bond ETFs by relative Size

One of the Best Bond ETFs is iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)
  • Great Brand: LQD is perhaps the most recognizable name in Corporate ETF space and was the #1 on FED SMCCF Purchase List in absolute amount
  • Longest Track Record: Established in July 2002, it has the longest track record of all the reviewed Funds
  • Liquid and diversified: Very liquid and diversified across over 2,200 Bonds
  • High Yield: With a longer-term and marginally more aggressive profile the spread is higher at 133 bps which explains most of the difference in Yield (2.7% before inflation) vs. Vanguard VCIT 
  • Strong Sponsor: BlackRock provides better transparency of holdings and analytics
  • FED Quality stamp: Below are the bonds that were heavily bought by the FED, before it started winding down the COVID-19 related program.
SMCCF FED ETF purchase programme - quantitative easing trading history LQD VCIT VCSH VCLT
FED Corporate Bond ETF Purchases - Click on the chart to read the review of the Funds

Corporate Bond ETF Category - Best Bond ETF List

Below are some of the Best Fixed Income Index Funds in 2021 as regarded by Market Participants in Category “Investment Grade ETFs”. If you want to understand how the Spread (Credit Risk) for Investment Grade Bond Universe has evolved over time check FED data.

Click to enlarge

Corporate Category - Best Bond ETFs Links

HIGH YIELD CORPORATE BOND ETFS

Best Bond ETFs by relative Size

One of the Best Bond ETFs is SPDR Bloomberg Barclays High Yield Bond ETF (JNK)
  • JNK has a High Risk / Reward investment with substantial Credit Risk e.g. over 10% is in Energy Sector alone with other risky sectors like Aircraft part manufacturers
  • The fund is well-diversified with over 900 Bonds
  • Interest Risk is relatively lower than other categories because the Bonds are floating (not fixed) 
  • The FED was buying JNK ETF as part of its ETF Purchase Program (SMCCF)
  • However, close to 15% of the Fund is Rated CCC or lower with high Default Risk (see chart below that indicates risk before taking into account Coronavirus Market)

Before you consider High Yield...

  • This is the riskiest part (high risk / high returns) of the mainstream ETF Bond Universe (you can observe how the Spreads are much wider than the Investment Grade category). 
  • Remember, it is not unusual to see Bonds defaulting within these Funds. As such they tend to underperform during a downturn (similar to Equities, hence lower diversification benefit)
  • The ETFs have a very high correlation to Equities providing very poor diversification
Defaults are frequent - On the graph below High Yield is represented by (BB & B & CCC/C)
High Yield starts below BBB- while defaults are usually below 5% for Investment Grade. Source: S&P Global Fixed Income Research

High Yield Bond ETF Category - Best Bond ETF List

Click to enlarge

High Yield Category - Best Bond ETFs Links

INFLATION PROTECTION BOND ETFS

TIPS Characteristics

What is the difference between Treasuries and TIPS if real rates on them are roughly the same?

The real yield may be the same but they won’t react the same way to inflation / deflation. TIPS will protect you against inflation but will under-perform if inflation turns out lower than expected.

For Inflation-Protected Bonds, both Bond Face Value and coupon are adjusted to inflation so you get inflation protection. The downside is limited since you always get par price back. However, since inflation is much more common over longer time periods Bond’s face value would have gone up since issuance. This means that should price levels drop the face value will be reduced up to the floor level. If inflation drops more than expected Treasuries will outperform TIPS

In the below tables, the Yields are Real i.e. you need to add inflation to get the nominal yield that you will get from these Bonds (it’s just a market convention)

Inflation Protection Category - Best Bond ETF List

Click to enlarge

TIPS - Best Bond ETFs Links

MUNICIPAL BOND ETFS

Muni Characteristics

Muni bond ETFs are exempt from federal income tax but may be subject to an investor’s state and local income taxes. Muni Bond ETFs are especially advantageous for high earners with the highest tax rates. Given their increased risk profile these tend also to yield more than Treasuries. 

Yields tend to correlate with risks e.g. SPDR Nuveen Bloomberg Barclays High Yield Municipal Bond ETF (HYMD) – last of the list is exposed to local entities rated below Investment Grade. Its top exposures include Puerto Rico (High Yield), Ohio and, California. The Long term funds have a higher interest rate risk as the duration is between 6 and 10 years. 

Municipal Bonds Category - Best Bond ETF List

Click to enlarge

Munis - Best Bond ETFs Links

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All information found here, including any ideas, opinions, views, predictions expressed or implied herein, are for informational, entertainment or educational purposes only and do not constitute financial advice. Consider the appropriateness of the information having regard to your objectives, financial situation and needs, and seek professional advice where appropriate. Read our full terms and conditions.

FAQ

Fundamentally, the strategy is the same:

1. They track an Index and replicate its performance rather than making active bets.
2. They have low fees (expense ratios).
3. They are well diversified.
4. They are mainly run by the same Fund Managers (BlackRock, Vanguard, State Street).

But there are technical differences:

1. An Index Fund in a Mutual Fund and trades less frequently while an ETF trades like a Stock (continually).
2. Expense Ratios (Fees) are usually higher for Index Funds vs. ETFs
3. Index Funds can have exit fees.
4. However, ETFs can have trading commissions whereas Index Funds usually don’t.
5. There could be a minimum initial investment in an Index Fund vs. none for ETFs.
6. There could be tax related nuances depending on your geography.

iShares Core Total USD Bond Market ETF (IUSB).
iShares US Treasury Bond ETF (GOVT).
iShares Broad USD Investment Grade Corporate Bond ETF (USIG).
SPDR Bloomberg Barclays High Yield Bond ETF (JNK).

Are the Best Bond ETFs for Q3 2020in their respective categories assuming an Intermediate Time Horizon with 5 to 10 year duration and generating the highest Yields

Yes. The value of Bonds decreases with rising interest rates.
Think of it as an opportunity cost for an investor to keep holding on on Bonds that are generating less than newly issued at higher interest rates. Individual bonds don’t have that risk if you hold to maturity.
ETFs never mature and Bonds are rolled so some risk remains. But you can reduce risk by choosing Short Duration ETFs at the expense of lower Yield.

Bond funds do not have a fixed rate of maturity instead Bonds are rolled i.e. they include many bonds that are added or removed during the time you own the fund. It is good practice to match your investment horizon with the category of the fund (short / intermediate / long term)

While the underlying Bonds pay interest on a agreed schedule the Funds will pay this income in form of dividends

1) Understand your risk tolerance for Credit Risk.
2) Define your time horizon for ETF Category.
3) Minimize Fees.
4) Maximize Current Expected Yield.

The real yield may be the same but they won’t react the same way to inflation / deflation. TIPS will protect you against inflation but will under-perform if inflation turns out lower than expected.

Some of the biggest reference Bond ETFs include iShares Short Treasury Bond ETF (SHV), iShares 7-10 Year Treasury Bond ETF (IEF), Vanguard Short-Term Corporate Bond ETF (VCSH),iShares 20+ Year Treasury Bond (TLT), iShares National Muni Bond ETF (MUB), Vanguard Intermediate-Term Corporate Bond ETF (VCIT), iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), Vanguard Long-Term Corporate Bond ETF (VCLT) and SPDR Bloomberg Barclays High Yield Bond ETF (JNK)

The 5 largest ETFs that the FED is buying are: iShares iBoxx US Dollar Investment Grade Corporate Bond ETF, Vanguard Intermediate-Term Corporate Bond ETF, Vanguard Short-Term Corporate Bond ETF, iShares iBoxx High Yield Corporate Bond ETF, SPDR Bloomberg Barclays High Yield Bond ETF

Best Bond ETFs for recession are Treasury Bond ETFs, Aggregate or Core Bond ETFs and to some extent Investment Grade Bond ETFs. High Yield Bond ETFs are correlated to Equities and very high risk.

Best Short Term fund include SPDR NUVEEN Bloomberg Barclays Short Term Municipal Bond ETF (SHM) and iShares Short-Term National Muni Bond ETF (SUB)

Best Intermediate Muni Bond ETFs include iShares National Muni Bond ETF (MUB), SPDR Nuveen Bloomberg Barclays Municipal Bond ETF (TFI), VanEck Vectors AMT-Free Intermediate Municipal Index ETF (ITM) and iShares California Muni Bond ETF (CMF)

Best Long Term Muni Bond ETFs include VanEck Vectors High-Yield Municipal Index ETF (HYD),Invesco National AMT-Free Municipal Bond ETF (PZA),Invesco Taxable Municipal Bond ETF (BAB) and SPDR Nuveen Bloomberg Barclays High Yield Municipal Bond ETF (HYMD)

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About Raph Antoine 84 Articles
Raph Antoine is a Portfolio Manager and Institutional Advisor that witnessed first-hand the 2008 Global Financial Crisis and the 2011 European Debt Crisis working for some of the most prestigious names in the financial industry. Raph has experience across multiple asset classes including Fixed Income and Equity products as well as Special Situations and Restructurings in multiple jurisdictions. Raph holds an MSc in Financial Engineering and is a CFA (Chartered Financial Analyst) Charterholder. He usually rides one of his two bikes. Rarely, a Canyon Ultimate CF SLX 8.0 (that is currently in family's attic) and most of the time a Gravel Pinnacle Arkose (his favourite) that he used to Cycle the World.
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Jesse32
Jesse32
2 years ago

This is great and presented in a concise manner. Exactly what I’ve been looking for. Sometimes too much choice is confusing. These main funds are more than enough for the average investor looking deploy savings through a diversified portfolio. How frequently will you update these tables? Thank you!

Jesse32
Jesse32
2 years ago
Reply to  Raph Antoine

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Paolo
Paolo
2 years ago

Could you please add tickers? Much easier to trade. Thanks!

JohnPF12
JohnPF12
2 years ago

Very interesting article

significantnumbersRE
significantnumbersRE
2 years ago

Looks good and its definitely helpful! I would just add that it might be worthwhile to include max drawdowns to the KPIs you are benchmarking as stability of the invested principal is quite a pertinent consideration when choosing bond funds

Gony
Gony
1 year ago

Probably the most comprehensive guide for Fixed Income ETFs

parrot
parrot
1 year ago

one of the most comprehensive narration for a newbies!
would be amazing to get it updated…

Pawel
Pawel
1 year ago

Hi, You mentioned that increase in interest rates will decrease Bond ETF prices. Right now we have very low-interest rates (when equities are doing fine which is sometimes references as unseen in the past). Is it now a good time to buy Bond ETF ? There is high probability that they will go down in the future? Let’s say that markets will go rapidly down right now, will the current background (low-interest rates) still allow bonds to react positively (with negative correlation) to equities falling? So in essence won’t the current condition deteriorate the expected diversification effects of bonds? Is… Read more »

Last edited 1 year ago by Pawel
Raj Dugel
Raj Dugel
1 year ago

Hi Raph, Thank you for the amazing analysis of various bond-equities. Given their impossibly low yield, esp negative yield of aggregate ETF’s, should an investor do one of below: Tilt the asset allocation towards a greater percent of stock holdings? For instance, if my usual asset allocation is 60% stocks, shall I increase the allocation to 70%? Buy indivdual bonds, instead of ETF’s, and hold the individual bonds till maturity? For instance, shall I buy a ladder of LONG term bonds that mature every year? Divest bond holdings by buying alternatives, esp REIT ETF’s ? Doesn’t holding onto a guaranteed… Read more »

Hamik
Hamik
1 year ago

Hi. 2 questions.

  1. Are ETF’s superior to mutual funds? Can you pick one or the other and expect reasonably equal levels of performance?
  2. Is the interest rate risk any different for Bond ETFs compared to individual bond holdings (durations for both being essentially equal)? My current assumption is that ETFs mitigate the risk slightly; but this mitigation is negligible.

Thanks.

ROBERTO ZANI
ROBERTO ZANI
3 months ago

Please please dear Raph, write this article for the european investors too… Thank you!

Beau W.
Beau W.
3 months ago

After reading about and listening too Robert Kessler about Treasury bonds and the long term saftey of them I’m going to keep putting my money in Treasury bonds. The long term saftey helps me sleep better.