Kavan Choksi Discusses the Advantages of Adding Bond ETFs to the Portfolio Over Individual Bonds
Much like other ETFs, bond ETFs also make a correlating index or underlying investment product, but they are not as simple as others. Most bonds are fixed-income assets and are not very liquid. Bond ETFs, however, have to be liquid, and available to the secondary markets. In th opinion of Kavan Choksi bond ETFs offer more advantages offer individual bonds to most investors. Their advantages range from more consistent risk characteristics to greater diversification.
Kavan Choksi points out the benefits of including bond ETFs in the portfolio over individual bonds
Portfolios of individual bonds to have their benefits, but most of them are associated with control over security-specific decisions and come with an associated “control premium. Bond ETFs, on the other hand, allow for easier reinvestment of capital and income, and can be relatively cost effective. There are many reasons why a large number of investors choose to add bond ETFs to their portfolio instead of individual bonds. Some of these reasons include:
- Diversification: Global investment-grade fixed income markets are known to play a critical role as a stabilizing force in investment portfolios and help diversify riskier investment vehicles like equities. Having access to a widely diversified portfolio of bonds is among the top advantages of owning a bond ETF, as it allows for improved ease of use and simplicity. Through just a single holding in a bond ETF, investors would be able to access hundreds if not thousands of bonds that are diversified among credit quality, issuers and term structure. Building such a diverse portfolio requires a certain scale and size of investment, much like an ETF.
- Low costs: Investing expenses matter more than ever in a low-yield environment. This is particularly true for the bond market, where costs erode a larger share of returns than they have in the past. Lower costs should ultimately translate to superior net returns and better portfolio performance over time, all other things being equal. Bond ETFs have greater economies of scale than most individual portfolios created by advisers. Their size advantage usually translates to reduced execution expenses. ETFs also tend to have superior bargaining power in comparison to smaller scale and individual investors, as they have access to greater number of counterparties and dealerships. This access can ultimately translate to more favorable pricing.
- Liquidity and transparency: As bond ETFs are listed on the exchange and can easily be traded anytime during market hours, they also have a greater liquidity in comparison to a portfolio of individual bonds. Bond ETFs additionally have more transparency in pricing, and what investors are asking and bidding. Credit ratings, data on duration and yield are available readily for ETFs.
Kavan Choksi points out that in comparison to individual bonds, bond ETFs support a more timely investment of initial principal as well as periodic income cash flow. They also have more consistent risk characteristics than individual bonds, making partial liquidations a lot easier. On the whole, budget-friendly and diversified ETFs provide building blocks for setting and maintaining asset allocation strategies, and are quite a smart investment.