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How useful is an ETF Bond?

ETFs (Exchange Traded Funds) are all the rage – but do they also exist for bonds? And how useful is an ETF Bond? As shown in the previous blogs, the asset class of bonds is a crucial part of a portfolio. However, since many government bonds and also some corporate bonds with good credit ratings yield negatively or only minimally positively in the current low-interest environment, it is questionable whether their inclusion in a portfolio makes sense at all.

Institutional bonds also for private investors?

In addition, many corporate bonds are only tradable with a minimum amount of 100,000 euros. Therefore, they are not viable for broad diversification of a private investor’s portfolio. However, there is a way to invest in bonds in a broadly diversified manner, even for small portfolios.
Find out what exciting opportunities the high-yield bond market offers.
What are bonds and why do they belong in every portfolio?

Active versus passive management

This is done through ETFs (Exchange Traded Funds) on bond indices, also called bond ETFs. ETFs are passive investment funds that can be traded on the stock exchange. They are called passive because bond ETFs track an index without active fund management. This significantly reduces the costs for the investor. There are thousands of bond ETFs available on the market. Therefore, it makes sense to consider in advance what form of bonds should be represented in the index. But here lies the rub.

A bond index is a compilation of several bonds of a certain region, risk category or the same type of bond type. t

Examples include:

    • Government bonds index;
    • Lien bonds index;
    • Convertible bonds Index;
    • Corporate bonds Index;
    • High-yield corporate bonds index;
Learn more about bonds in our free information brochure: “7 Good Arguments for Corporate Bonds”.

If one focuses on high security, such as government bonds in the Eurozone or US government bonds, then the expected return will be very low or close to zero.

If you want a higher return, you must run a little more risk and should, for example, bet on an index of corporate bonds. Those who want to achieve a yield higher than, let’s say, 5 %, can target an index of high-yield bonds. A combination of several indices and thus ETFs is also conceivable since these are tradable in very small minimum sizes.

Well-known indices in the bond segment are, for example, the following three bond indices:

  • FTSE MTS Eurozone Government Broad Investment Grade;
  • Bloomberg Euro Corporate Bond Index;
  • iBoxx MSCI ESG USD FRN Investment Grade Corporates.

Physical or synthetic index replication?

A bond ETF replicates the performance of a bond index. This is done either through physical or synthetic replication. In the latter case, the index is replicated via a (“Total Return Swap”). The ETF enters into a contract with a financial institution that agrees to pay the ETF the index return in exchange for a fee.
Physical replication means that the ETF actually buys the securities in the same proportion as they are included in the index. So, investors who pay into the ETF effectively invest in the securities present in the index. If the index adjusts its stock selection or weightings, the ETF automatically follows suit.

Cost efficiency of ETFs

The ETF aims to replicate this index in terms of performance and to achieve maximum cost efficiency in the process. The replication is automated, and no fund management controls this process manually. This is different from bond funds, which also focus on bonds but are actively managed.

Price growth & risk rating of an ETF Bond

The returns of the bond ETF derive from the interest on the bonds as well as from potential price gains. It is difficult to define an average return per year in per cent. With bond ETFs, you do not receive interest as you would if you invested directly in bonds. All profits flow into the fund volume and are usually reinvested (“accumulating ETF”). The profits of the bond ETF then accrue for the investor through an increase in the price. The risk is manageable, as bonds with good credit ratings are not among the riskier investments like shares, for example. However, they still have a higher risk than, for example, the classic forms of savings such as overnight money and fixed-term deposits.

Genève Invest's assessment of bond ETFs - For whom are bond ETFs suitable?

“In larger portfolios, it makes more sense to represent the bond component with direct investments. Only these generate a calculable cash flow..”

ETF Bonds are a proven means of covering the bond side efficiently and cost-effectively, even in smaller portfolios, thus including safety components in the portfolio. According to Genève Invest’s many years of experience, on the other hand, it makes more sense in larger portfolios to represent the bond side with individual direct investments in bonds, as only these pay out a predictable and calculable interest coupons and generate a high cash flow with the fixed maturities, which is particularly popular with retirees to generate a regular additional income. Bond ETFs, on the other hand, cannot accomplish these tasks.

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