Are bond ETFs a good option in the current market?

Todd Schlanger, an investment strategist from Vanguard, gives his view on bond ETFs

Are bond ETFs a good option in the current market?

With returns in upcoming years expected to be lower than in recent years, advisors are under pressure to be creative as they help their clients build effective portfolios.

For Senior Investment Strategist at Vanguard, Todd Schlanger, one particular product type stands out as a good solution in the current environment: bond ETFs, which Schlanger sees as having four distinct investor advantages. “They provide a broadly diversified portfolio in a single holding, they can be implemented at a low cost, they’re liquid and transparent, and they provide easy reinvestment of capital and income,” Schlanger says. “Individual bonds also have advantages but they come with a ‘control premium’ which makes them have a higher cost.”

Although the ETF market continues to grow at a rapid rate, many advisors are still building portfolios using individual securities, particularly on the fixed income side. While individual bonds still have a role to play, bond ETFs provide investors with access to a diversified basket of hundreds (sometimes thousands) of bonds in a single issue. They also help to cut costs, which in the current market is a top priority for the majority of investors. “Considering where yields are today relative to history, costs make up a larger and larger percentage of returns,” Schlanger says.

With valuations in developed markets looking full, advisors should be preparing their clients for muted returns. Looking to the next decade, Vanguard forecasts equity returns in the 5 – 7 % range and fixed income returns in the 2 -3% range. Therefore, in a balanced portfolio (made up of 60% equities and 40% bonds), investors are looking at real returns of between 3 – 4% for the next ten years once inflation is accounted for. “That’s down 100 or 200 basis points relative to history,” Schlanger says. “Tying that in with the message around ETFs; they are an effective way of implementing asset allocation at a low cost, which is really important in the lower return environment.”

Schlanger encourages advisors to concentrate on the factors within their control: asset allocation, implementing investments at low cost, and encouraging clients to save more into their portfolios. He also believes that advisors should focus on becoming their clients’ behavioural coach. “A lot of the work we’ve done on our advisor alpha framework shows the behavioural side to be where advisors can add the greatest value to client relationships,” Schlanger says. “When you have periods of uncertainty and volatility, advisors need to be that circuit breaker for their clients. Advisors should help their clients stay disciplined and on course with their plan; that can yield benefits in the long run.”

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