3 Bond ETFs for a Low-Yield Environment

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Bond-fund yields look underwhelming relative to cash yields today, but bonds can still serve a valuable role in investors' portfolios. Joining me to share some favorite bond exchange-traded fund picks is Alex Bryan. He's Morningstar's director of passive strategies research in North America.

Alex, thank you so much for being here.

Alex Bryan: Thank you for having me.

Benz: Let's get right into your first pick, Alex. This is kind of a tried-and-true option, maybe even a one-and-done option for many investors. This is Vanguard Total Bond Market Index ETF. Let's talk about why you like it.

Bryan: So, I like this fund because it offers broad exposure to the U.S. investment-grade bond market. It weights its holdings based on market value, which tends to tilt it toward really high-quality government bonds and agency mortgage-backed securities. About 70% of its portfolio is invested in AAA rated debt. So, those bonds tend to do well in environments when stocks don't do very well. There's not a lot of credit risk here. And to the extent that interest rates go down further, that can provide some capital appreciation here. I think this is a really good portfolio because it's really well diversified across different sectors, and it doesn't have a lot of issuer risk in it. So, I think if you're looking for a way to diversify away from stock risk, this can provide a nice defensive counterweight to that.

Benz: A more conservative option, because it's shorter-term, would be Vanguard Short-Term Bond Index ETF. Let's talk about that one. That's presumably for investors who have even shorter time horizons for their money. Maybe they expect to spend that money within the next two or three years or so. Vanguard Short-Term Bond ETF, why do you like that one?

Bryan: Yeah. So, this fund offers exposure to the short end of the investment-grade market, invest in bonds maturing between one to five years. It owns both government as well as corporate bonds. Like the Vanguard Total Bond Market ETF, it is very conservative. Most of the portfolio is parked in AAA rated securities. But I think this is a particularly attractive option if you are looking at the yield curve and thinking that long-term bonds currently may not be offering very good compensation for their additional interest-rate risk. So, if that's a concern, or if you need money in a couple of years, this is a really good option to consider. It tends to be less sensitive to changes in interest rates than the broader bond market. So, that means that if interest rates were to ever go up, which presumably at some point, they will, these bonds tend to lose less of their value than longer-term bonds. So, this is a safer option than a broad bond market fund, which might make it a really good option if you are a bit more risk averse.

Benz: So, let's talk about a pick for investors who are potentially a little bit more risk-tolerant, that they are willing to tolerate some price fluctuations in exchange for a slightly higher yield. A fund you like in this sort of category is iShares Broad USD Investment Grade Corporate Bond. The ticker is USIG. Why do you like that one, Alex?

Bryan: So, I think this is a really good option if you're looking for a slight yield pickup over what the broad U.S. investment-grade market offers, but you want to keep risk in check. So, this particular fund invests in a broad range of investment-grade U.S. corporate debt, with bonds ranging anywhere from one year to maturity all the way up out the yield curve. This fund effectively diversifies issuer-specific risk, sector-specific risk, and I think this is a really good option to pair with a core bond holding like Vanguard Total Bond Market ETF. So, if you're looking to get a slight yield pickup but you don't want to venture out into high-yield territory, I think this is a really good way that you can get some additional yield without taking on a lot of risk. This is also one of the lowest-cost investment-grade corporate-bond funds out there. It only charges 6 basis points. So, I think that makes it a really attractive way to get exposure to this area of the market.

Benz: Alex, timely discussion. Thank you so much for being here.

Bryan: Thank you for having me.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.