Fixed Income ETFs
Thus far in Part III, all of the chapters have addressed investing in the equity markets. This chapter addresses a larger part of the financial markets: fixed income.
Fixed income plays a crucial role in most investors’ portfolios because the asset class offers stability and income. On average, individual investors place more than 50 percent of their long-term savings in fixed income securities. That means proper fixed income ETF analysis and selection plays an important role in portfolio management.
By dollar weight, the nearly $30 trillion public U.S. fixed income market is far greater in size than the public U.S. equity market. But that is not evident from the number of fixed income exchange-traded funds (ETFs) available to investors. Fewer than 10 percent of the U.S. ETF issues track fixed income indexes. That said, 2009 may prove to be the year of the bond ETF as companies scramble to make up for lost equity revenue.
The lag in fixed income ETF issuance is due to the greater difficulties managing fixed income portfolios using an ETF structure. The underlying bonds in a fund must have adequate liquidity so that authorized participants (AP) can easily trade these securities. (See Chapter 2.) It would not be possible for the APs to create complete creation baskets that include all of the individual securities in the indexes without adequate liquidity, including an active derivatives market. The costs to buy and sell securities would be too large, ...