Bond funds generally are in the form of mutual funds or ETFs (exchange-traded funds). While both bond mutual funds and bond ETFs provide investors exposures to fixed-income markets and various degrees of diversification, ETF bond funds also afford active investors the stock-like trading liquidity, a desirable feature, especially considering the non-unified market trading of individual fixed-income securities including various bonds. ETF bond funds track different bond indexes of different bond types and bond maturities, and the best ETF bond funds are the ones that can deliver optimal future returns from the particular group of bonds they track.
One way bond indexes are constructed is by grouping bonds with similar maturities such as short term, intermediate term or long term. Consequently, many ETF bond funds can also be identified using the maturity feature of the bond holdings in a bond ETF. Since prices of bonds of different maturities can be sensitive to interest-rate changes to different degrees, certain ETF bond funds may perform better under a given interest-rate environment and economic conditions. For example, if interest rates are expected to rise due to economic growth and inflation concerns, the best ETF bond funds are likely those that hold bonds of short-term maturities, as bonds of long-term maturities lose value the most when interest rates rise.
Bond indexes are also designed based on particular types of bonds that an index tracks. Different types of bonds present different level of risk and yield, such as government bonds vs. corporate bonds. Therefore ETF bond funds that track different bond indexes of different types of bonds may perform differently depending on the state of the economy and investor risk appetite. For example, when the economy improves and investor risk aversion subsides, ETF bond funds of mostly holding corporate bonds can provide higher yield without the worry about a dip in bond value, potentially becoming the best performers.
Traded on the stock market, not all ETFs possess the same level of trading liquidity just like that some stocks are more actively traded than others. For ETF bond funds, any differences in trading liquidity among funds have their own causes. Since many ETF bond funds can essentially track the same bond indexes, to attract investors, fund management must demonstrate their trading ability in the underlying bond markets to adjust to investor demand for ETF shares. In turn, the more investors a bond ETF has, the more asset base the fund, and the higher the fund's potential trading liquidity.
All else being equal, the cost of owning ETF bond funds becomes a factor in deciding the best ETF bond funds. ETF bond funds generally are low in expense ratios but funds likely charge different amount of annual expenses. It is up to investors to compare funds with different expense ratios. For example, Vanguard offers its various ETF bond funds with an ultra-low expense ratio of 0.11 percent. In comparison, the expense ratio is 0.15 as charged by the popular iShares funds from Barclay.
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