# Bond ETF's?



## lyl (Apr 1, 2017)

Hello everyone,

I have been reading and doing some investing recently however I have much to learn. Up until now I have only purchased individual stocks and ETF's containing a basket of stocks. I am currently in cash and am planning to jump in again soon. My plan is to buy some stock indexes (Dow, S&P etc) by way of ETF's (DIA, VOO) as I wish to eliminate some of the risk with individual stocks, however I would also like to include bonds. 

I have never bought bonds before and even though I understand the basic concept of holding debt until maturity, collecting interest along the way and in the end receiving your principle I am not interested in government bonds, only corporate. Also I do not wish to own individual corporate debt but rather a basket by way of an ETF. I am finding many corporate bond ETF's just by searching the Internet however I am at a loss to understand the difference between a good one and bad.

It would seem that like any stock ETF you could gain or loose capital gains should you sell it lower than you bought it. However unlike certain stocks there are no dividends, there should be interest payments on a regular basis however it seems you can also be negative in interest on a regular basis. Do corporate bond ETF's drop in purchase value simply as a result of interest rates rising? And if interest rates continue to rise as many expect should I expect the purchase value to drop but the interest payments to increase? Likewise if interest rates to fall the value of my bond ETF should rise but my regular interest payments would be negative?


----------



## james4beach (Nov 15, 2012)

With bond ETFs (just like bond mutual funds) you have to think of them in terms of total return. Yes the price of the bond ETF will fluctuate and over short periods of time, you may experience a net loss -- that's after considering all price moves on the bonds *and* interest paid.

"Short" is relative to the average portfolio maturity of the fund. For example XSH is a corp bond ETF with 3 year average maturity and the price of the fund can fluctuate so that you see a loss if you hold it less than 3 years.

LQD is an American corp bond ETF with 10 year average maturity and you could experience a loss if you hold it less than 10 years.

However once you hold them beyond that time length (whatever the avg maturity is) then it's very unlikely you will see a loss. A positive return is virtually guaranteed, even if interest rates rise.

This is why investment time horizon is very important. If you might need this money within a couple years, then the only corporate bond ETFs you should consider are short term bonds such as XSH, VSC (Canadian short term corporate bonds). However if you are willing to tolerate potential losses over the next 10 years, then you could go with any one of the more generic bond funds.

As a general rule, the farther out in maturity you go, the higher your returns will be. However you should balance that against the potential losses due to volatility that you might see. For example, nobody on these boards would recommend a "30 year" avg maturity bond ETF. Yes the returns might be pretty good, 40 years from now, but it could also drop substantially in value in the next 30 years.

For selecting a corp bond ETF, here are the key things to look at:

1. credit grade of their investments. Is the paper mostly AAA, AA, A, sub-A, etc?
2. what is the portfolio average maturity? You should intend to hold it at least this long
3. what is the 'duration' measure? Higher the duration, more price volatility you might see

Compared to government heavy portfolios, additional info you should consider is that low grade bonds (those mostly below BBB) have a higher risk of loss due to *default*. When I said previously that holding for a certain length guarantees a positive return, this is not true for low grade corporates -- they may still have big losses due to defaults.

The ETF issuers all publish these. For example XSH is mostly A paper but also 31% in BBB, about typical for corporate bond funds. The average maturity is 3.1 years so you should expect to hold it about 3 years (you will have a positive return if hold it this long). Duration is 2.9 which is a measure of interest rate sensitivity/volatility. XSH with duration 2.9 is much less volatile than XCB with duration 6.2.


----------

