3 Great Core Bond ETFs

Editor’s note: This content originally aired in September 2022. The transcript was updated on Feb. 16, 2023, to remove references to 2022 that are no longer relevant.

Today, I’ll walk through three core bond ETFs that provide broad, diversified exposure to the fixed-income market at a sensible cost. These ETFs are Morningstar Analyst Rating Medalists, meaning we expect these funds to outperform on a risk-adjusted basis over the long run.

3 Great Core Bond ETFs

These exchange-traded funds earn Morningstar Analyst Ratings of Gold or Silver.

1. iShares Core Total USD Bond Market ETF IUSB
2. Vanguard Total International Bond ETF BNDX
3. Fidelity Total Bond ETF FBND

The first ETF on my list is Gold-rated iShares Core Total USD Bond Market ETF, or IUSB. This strategy tracks the Bloomberg U.S. Universal Index, which includes U.S.-dollar-denominated, fixed-rate, taxable bonds across the entire credit spectrum with at least one year until maturity. Bonds are weighted by market value, promoting low turnover and harnessing the market's collective wisdom about the relative value of each bond.

The fund primarily consists of U.S. Treasuries, agency mortgage-backed securities, and corporate bonds. This includes a small slice of high-yield debt totaling about 8% of the fund's assets. This portfolio closely resembles the Bloomberg U.S. Aggregate Bond Index aside from its slug of junk bonds. It ticks slightly lower in duration and quality than the Agg, but its minor tilt toward riskier bonds has paid off over the long run.

Diversification is a hallmark of IUSB's portfolio with its 14,000 bonds in tow. This ETF pushes the Agg's investment universe one step further and better reflects the opportunity set available to active managers. IUSB provides a solid foundation of U.S. Treasuries and dollar-denominated corporate bonds and securitized debt at the lowest cost in its category, making it a great core option for the bond sleeve of investors' portfolios.

Next on my list is Silver-rated Vanguard Total International Bond ETF, or BNDX. This ETF takes abroad the same cheap, diversified approach as IUSB. Its portfolio includes investment-grade bonds issued in currencies other than the U.S. dollar with maturities greater than one year. Bonds are weighted by their market value.

Eligible bonds include government, government-related, corporate, and securitized bonds from developed and emerging markets. Credit risk comes with the territory for bonds from corporate and emerging-markets issuers, but this fund isn't overexposed to either sector. Instead, this fund's performance will be primarily driven by interest-rate risk and changes to the term structures of the Japanese, eurozone, and British yield curves.

The fund uses forward contracts to hedge its currency risk, which gives it cleaner exposure to local bond returns. However, its performance will not match the local market returns because forward currency rates don't move in lockstep with spot rates. But hedged exposure to foreign bonds is a wise approach as the performance of unhedged bonds can be dominated by changes in currency prices.

The fund's best trait is its low fee. It charges 8 basis points annually, 37 basis points cheaper than the average toll taken by its peers.

The final ETF on my list is Gold-rated Fidelity Total Bond ETF, or FBND. This is a great active fund for investors to build their portfolio around. This fund takes a flexible approach to portfolio construction, moving away from benchmarks when opportunities call for it. Besides investing in the typical investment-grade corporate credit, mortgages, and U.S. Treasuries that constitute the Agg, the portfolio managers may allocate up to 20% to non-investment-grade bonds, including high-yield and emerging-markets debt. While this can lead to higher credit risk, the managers usually keep the fund's duration within a third of a year of the Agg, which helps keep the fund afloat when rates spike.

The fund has made shrewd allocation calls for the strategy. It found itself slightly more exposed to credit risk than competitors during the depths of the pandemic in 2020, causing the fund to fall behind peers. But the strategy hiked its stake in credit by taking advantage of the wave of new credit issues that came to market after the pandemic downturn, while trimming its exposure to U.S. Treasuries and agency mortgage-backed securities. This put it in position to outperform its average category peer in 2020 overall.

This fund charges one of the lowest fees in its category by actively managed funds at 36 basis points. And the diversification theme continues with this fund which holds 2,000 bonds in its portfolio. This strategy has proved its ability to earn back its fee and more, and it deserves a look as a core bond holding for all investors.

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