Our Take on the Bond ETF Dilemma
The problem is in the index, not the ETF.
A lot of noise has been made recently about the trouble that bond ETFs have been having when it comes to tracking their respective indexes. It takes two to create tracking error: an ETF and its index. So, how come all the focus is on the bond ETF? The indexes certainly play a part in these deviations and maybe, just maybe, in the end, the index is wrong and not the ETF.
For anyone not familiar with bond indexes and how they are constructed and calculated, there are a few things that distinctly set them apart from equity indexes. The most important being that, with equity indexes, you can generally expect the underlying securities to be liquid. That is, they trade every day, and what that really means is that you have market-driven price discovery for stocks every day. So, calculating the proper value of an equity index is usually a pretty straightforward exercise. You weight the stocks according to the index methodology (market capitalization being the most common), multiply that by the market-driven price, and sum the results.