Low fees not main draw to bond ETFs

Fixed-income exchange-traded funds have exploded in popularity, but low costs aren’t the main draw for financial advisers as they are with equity ETFs.

Fixed-income ETFs broke out last year, when they recorded inflows of $43 billion, more than double the amount in 2010. And they don’t show any sign of slowing down. They had $39 billion in inflows year-to-date as of Sept. 30 — the most of any ETF asset class, according to Morningstar Inc.

Although the growth of equity ETFs has been driven largely by their low costs, advisers are drawn to fixed-income ETFs primarily because of their convenience and liquidity, according to a survey of 200 advisers by provider Guggenheim Investments.

More than 70% of advisers cited those factors as ETFs’ biggest advantage over individual bonds or bond mutual funds; just 16% said cost is the biggest advantage.

The convenience and liquidity advantages of bond ETFs are most apparent when compared with the alternatives, said Bill Belden, head of product development at Guggenheim. “Individual bonds have costly spreads, and mutual funds don’t have the continuous pricing,” he said.

Much like equity ETFs, bond ETFs let advisers slice and dice the market to get the specific allocation they are seeking. And because the funds are traded intraday on an ex-change, it is relatively easy to move in and out of a bond sector.

That liquidity comes at a cost, though, particularly in less liquid markets such as municipals and high yield. When there is increased selling pressure, muni bond and high-yield-bond ETFs tend to trade at premiums to their net asset value, much like closed-end funds. So an investor looking for a quick exit may have to pay in the form of higher transaction costs. Those costs are still lower than what spreads would be in trading individual bonds, Mr. Belden said.

The focus on liquidity is a surprise, particularly in light of the continuing ETF price war among some of the biggest providers.

BlackRock Inc., The Charles Schwab Corp. and The Vanguard Group Inc. have gone tit for tat with cuts to their ETF fees over the past few weeks, though they have been aimed largely at equity ETFs.

BlackRock did slice the expense ratio of the $15 billion iShares Core Total U.S. Bond Market ETF (AGG) to 8 basis points, from 22. It is now 2 basis points cheaper than the $17 billion Vanguard Total Bond Market ETF (BND).

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