Holding Down Costs With Bond ETFs

With the vast array of investment options out there, one thing is for sure: asset class matters when trading fixed-income exchange traded funds (ETFs). But how can an investor keep the costs down when it comes to bonds?

A study conducted by Matt Hougan and Dave Nadig over at Index Universe indicates this and concludes that the more liquid the underlying market, the lower the average premiums and discounts.

• First, they looked at Treasuries and concluded that investors shouldn’t worry about premiums and discounts in traditional Treasury ETFs. They did find, however, that premiums and discounts got larger as one moved out of the yield curve.

• Next, they looked at agency bonds such as Barclays Agency Bond Fund (AGZ), and concluded that both the average and extreme premiums and discounts were small.

• The third asset class analyzed were Treasury Inflation Protected Securities (TIPs), which are slightly less liquid than the two previously mentioned asset classes, but still resulted in small average and extreme premiums and discounts.

• The fourth class analyzed were blended funds, and the conclusion was that the illiquid corporate exposures had an impact on premiums and discounts.  Of the four blended funds looked at, three traded at a premium every day.

• Premiums and discounts really took off in the corporate bond category, where all four ETFs analyzed traded at average premiums and discounts of 2% and consistently traded at a premium.

• For high-yield bonds, the data suggest that the average premium shrinks, but absolute premiums and discounts increased.

• Lastly, the notoriously illiquid municipal bond category was a bit different, mainly because of the methods that the providers of these funds are using.  Those that utilized cash creations had high average average premiums and discounts. Those premiums and discounts shrink with cash creations.

In conclusion, tighter premiums and discounts can be found in the more liquid fixed income ETFs and are not an issue for traditional Treasuries. As for bond ETFs in general, they enable investors to gain the kind of diversity that would be cost-prohibitive for most small investors to achieve.

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