Invest in bond ETFs

Bond ETFs are collections of bonds that can be traded on stock exchanges. Find out how they work and how you can invest in them.

Bonds are essentially IOUs issued by a company or a government. The bond issuer promises to pay regular interest for a specific term, while it has the use of your money, and then repay the original loan at the end. Exchange traded funds (ETFs) are collections of investments, in this case, bonds, that are traded on stock exchanges.

The global bond market was around $123.5 trillion (around £89 trillion) in 2020, so investors have a lot to choose from when it comes to finding the right bond.

Investment jargon explained

Liquidity. This refers to how easy something is to convert to cash. Houses are considered to be fairly illiquid, while shares are semi-liquid.

Default. A default is a failure to repay. You might default on your mortgage if you don’t make the repayments. As bonds are effectively you lending money to governments or companies, they could default.

Bond yields. This is the return you get on a bond and comes in the form of a regular income, typically monthly.

Name Product Ratings Finder rating Customer rating Min. initial deposit Price per trade Frequent trader rate Platform fee Offer Link
Finder Award
OFFER
Freetrade
Finder score
★★★★★
User survey
★★★★★
★★★★★
Expert analysis
★★★★★
User survey
£0
£0
N/A
£0
Claim your free share worth between £3 and £200. Capital at risk.

Capital at risk

Platform details
FREE TRADES
eToro Free Stocks
Finder score
★★★★★
User survey
★★★★★
★★★★★
Expert analysis
★★★★★
User survey
$50
£0
N/A
£0

Capital at risk

Platform details
OFFER
InvestEngine
Not yet rated
Not yet rated
Not yet rated
£100
£0
N/A
0% - 0.25%
£50 welcome bonus for new customers. Subject to minimum investment. T&Cs apply. Capital at risk.

Capital at risk

Platform details
Barclays Smart Investor Investment ISA
Not yet rated
Not yet rated
Not yet rated
£0
From £3
N/A
£4 to £125 per month

Capital at risk

Platform details
Finder Award
FREE TRADES
Freetrade stocks and shares ISA
Finder score
★★★★★
User survey
★★★★★
★★★★★
Expert analysis
★★★★★
User survey
£0
£0
N/A
£3 per month
Claim your free share worth between £3 and £200. Capital at risk.

Capital at risk

Platform details
interactive investor stocks and shares ISA
Finder score
★★★★★
User survey
★★★★★
★★★★★
Expert analysis
★★★★★
User survey
£0
£7.99 (with one free trade per month)
£0
£9.99 per month

Capital at risk

Platform details
loading

Compare up to 4 providers

What is a bond ETF?

There are 2 main types of bond ETF:

  • Sovereign. Bond ETFs based on indices of bonds issued by the governments of sovereign nations, including the US. This divides into developed and emerging markets. Emerging market bonds will generally pay a higher yield because they come with a higher risk of default (when an issuer can’t repay the bond).
  • Corporate. These ETFs track indices of bonds issued by companies. These may be high quality international blue-chips (“investment grade”) or high yield, which are higher risk companies. Companies may be considered higher risk because they have higher debt levels, are in “at risk” industries, such as retail or leisure, or have been badly run.

However, there is a lot of variation even within these 2 main categories. Bond ETFs may focus on specific regions (the US treasury market, for example), or specific corporate bond sectors. Some ETFs will weight their securities by credit quality – the higher a company’s rating, the larger share it will have; or maturity – longer-dated or shorter-dated bonds may be given preference. You can get bond ETFs that specialise in inflation-linked bonds, such as the US Treasury Inflation-Protected Securities (TIPS) market.

Green bond ETFs

If you’re looking for a lower risk investment that’s also doing its bit for the environment, there is the emerging category of green bonds, which offers specialist ETFs. These bonds borrow money for specific green projects, converting a factory to renewable energy, for example. These will be ring-fenced from the wider company and offer an option for ESG-conscious investors.

Bond ETFs vs bond mutual funds

There are 2 main approaches to collective investments in bonds. We cover how each one works below.

Bond ETFs

Bond ETFs track specific bond indices. Investors can target specific markets such as US treasuries or European blue chip companies. They will generally be well priced, liquid (easy to sell) and transparent. They’re widely available on investment platforms as they trade “on exchange”, which means they’re listed on stock exchanges. The downside is that if they’re market-capitalisation weighted, investors can end up with their largest weighting in issuers with the highest debt levels.

Bond mutual funds

These have a dedicated manager who actively seeks out the best opportunities in an individual market, and should be adept at managing liquidity and risk, plus they can sell out of securities where the prospects are weaker (whereas a passive strategy has to hold whatever is in the index). Costs tend to be higher in these cases, which can be a significant drag in a low-return asset class such as bonds. Equally, a lot rests on the ability of the fund manager. Good fund managers can add a lot of value, but it’s not always easy to spot them ahead of time.

What are the best bond ETFs?

The performance of individual bond ETFs will vary significantly. A lot depends on the prevailing market environment. In normal conditions, high quality government or corporate bonds might be expected to do better in a tougher economic climate as investors look for safety. Higher yielding or emerging market bonds will do better when there is greater risk appetite. A better economic environment also reduces the risk of defaults.

However, more recently, bond markets have been influenced by central bank interventions. The bond buying programmes (or quantitative easing) have served to support certain parts of the bond market. This has, in certain instances, broken the link between economic growth and bond performance. For example, US Treasuries have continued to perform well since the start of 2021 even though inflation has been high and economies have been recovering.

How expensive are bond ETFs?

Bond ETFs will typically be cheaper than active mutual funds, which have a dedicated fund manager deciding which bonds to buy and sell. Generalised bond ETFs can start from less than 0.1%, but more specialist ETFs may cost more. In general, no bond ETF should be charging more than 0.5%, as it would be possible to get an actively managed strategy for the same price.

“Bond ETFs can be an effective and liquid option to access bond markets. They tend to work better for government bond markets, where their low cost is a significant advantage and there is less tracking error. Investors need to be more cautious in corporate bond ETFs, where tracking error may be higher and they can end up with high weights in the most indebted companies.”

Vanguard UK Gilts ETF

The Vanguard UK Gilts ETF holds 48 UK government bonds, across a range of maturities longer than 1 year. It aims to track the Bloomberg Sterling Gilt Float Adjusted Index by using a sampling strategy, investing in a portfolio of gilts that comprises a representative sample of the index components. It has done this successfully, with performance only differing by 0.01% over the past 12 months. There are only marginal differences on average maturity and coupon. Credit quality and duration are exactly in line with the index.

Vanguard charges 0.07% for the ETF. Costs have become increasingly important for developed market government bond investors as yields have fallen. Investors can’t afford to have too much of their return eaten up by fees. Distributions from the fund are made monthly, with the current yield sitting at 1.1%. The fund has its highest weighting in 25-year+ maturities. These comprise around one-third of the portfolio.

Pros and cons of bond ETFs

Pros

  • Bond ETFs give a diversified portfolio of bonds and offer plenty of choice for investors, from government to corporate bonds and emerging markets to green bonds.
  • Although the income available from bonds has dropped, once chosen carefully, they can still be the source of a stable, regular income.
  • Bonds can also provide diversification from stock market investments, reducing the overall risk of a portfolio.

Cons

  • Bond markets can be illiquid and therefore replicating the index exactly can be tricky. This is particularly true for certain corporate bonds. Sampling, whereby the ETF uses a smaller number of bonds to represent the index, helps manage this problem, but may not be as accurate. This can create some tracking errors, particularly during periods of volatility.
  • Equally, investors need to look closely at how the index is constructed. If indices are weighted by capitalisation, those companies with the most bonds (and therefore the most debt) may be a significant part of the overall allocation.

Bottom line

Bond ETFs can be a cheap and diversified way to access bond markets. However, investors need to make sure they know what they’re getting and feel comfortable with the risks. Bonds come in all shapes and sizes. Areas such as emerging markets or high yield bonds can be volatile, while government bonds should be lower risk. Central bank intervention in bond markets has had an impact on pricing.

Frequently asked questions

More guides on Finder

Ask an Expert

You are about to post a question on finder.com:

  • Do not enter personal information (eg. surname, phone number, bank details) as your question will be made public
  • finder.com is a financial comparison and information service, not a bank or product provider
  • We cannot provide you with personal advice or recommendations
  • Your answer might already be waiting – check previous questions below to see if yours has already been asked
Finder.com provides guides and information on a range of products and services. Because our content is not financial advice, we suggest talking with a professional before you make any decision.

By submitting your comment or question, you agree to our Privacy and Cookies Policy and Terms of Use.

Questions and responses on finder.com are not provided, paid for or otherwise endorsed by any bank or brand. These banks and brands are not responsible for ensuring that comments are answered or accurate.
Go to site