putting aside my own expectation of rising rates what are the considerations for holding a bond mutual fund vs a comparable bond ETF?
aside from the more obvious (intraday liquidity/ fee structures) are there any tax implications?
how does a diversified high grade corporate bond fund (vanguard) compare to similar etf (LQD) and why should I hold one or the other in my IRA/ taxable account?
Vanguard isn’t a good example because they’re going to have the same risk/return profile as a similar ETF…they’re both passive. So, if you’re asking if you should buy a passive mutual fund or an ETF, then it does really just come down to expenses and tax implications. If you don’t need daily liquidity, Vanguard is probably the way to go.
If your question is more about active vs passive, that’s a whole other can of worms. I will admit, bond funds have done a better job of lowering their tracking error, but it’s still very high for a passive fund. They simply can’t buy what’s in the benchmark so they have to try to replicate it. That can lead to unexpected results.
If you’re worried about rising rates, I would strongly advise you to stay away from passive bond strategies right now. Any passive fund benched to the Bloomberg Barclays Agg Bond Index (like BND) is going to have ~40% in Treasuries. Basically the only bond with more interest rate sensitivity is TIPS. Anyway, you don’t want to be holding a fund of 40% Treasuries when rates go up. Active funds (if the manager gets it right), can pull several different levers to hedge against rising rates and other risks. The trick is finding a manager than can do it on a consistent basis.
thank you for the thoughtful response…
yes… my question is as it relates to passive funds only…what are the tax implications - are the ETF “dividends” taxed the same as mutual fund distributions?
are there advantages to holding a passive broad market bond mutual fund versus a comparable passive broad bond market ETF? i see that some mutual funds example ishares actually have an “etf version”… do both have the same tracking error compared to benchmark and total return over long periods? everything ive read says they should be the exact same but i feel like im missing something.
I wouldn’t touch Bond ETFs with a ten foot pole. I’ve done the research and tried to like it and I still don’t like it.
Something (bonds) that are notoriously illiquid will remain illiquid even though you package them in a nice liquid ETF. When sh*t hits the fan and people dump the ETF (think JNK or HYG), those bonds are going to get dumped regardless of liquidity and you’re gonna get burned somehow. Just wait.
Passive mutual funds would be better imo. But I’d still rather have an active bond manager. They understand liquidity and hopefully can manage around market shocks far better than a passive bond index which will dump when there is no demand to buy.
The only reason one might use bond etfs is if you want to play with options.
Mutual bond dividends are taxed under the same rules as ETF dividends. What might be different though, is that mutual funds more frequently issue capital gains distributions, which the funds realize as they sells securities, whether to rebalance or to satisfy redemptions. These distributions are taxable, like dividends. ETFs are subject to the same rules but tend to not trigger capital gains events as often, due to the way they trade.
I am not convinced by the statement that active bond managers are “better” at managing liquidity. What evidence is there to substantiate this? What is likely to be true is that active managers have more discretion in when not to adjust their positions in response to market events. However, this could ultimately lead to an unbalanced portfolio or further liquidity problems if the market continues to move against the portfolio.
HYG and JNK will liquidate everything under the sun when panic strikes, regardless of price or liquidity, because they have to. A fund I work alongside trades corporates and muni bonds and saw some very massive gaps down in alot of corporate names in Jan-Feb 2016, right when HYG and JNK were seeing massive outflows. They took advantage and snapped up some deals. Massive moves in bond names like they’d never seen before. That is why I don’t trust bond ETFs. I’ll be very curious how it all ends with these things.
That being said, a smart manager won’t put 2-3% of his fund (or more!) in an illiquid name for precisely this reason. I’m sure there are stupid active managers that will, and will have an unbalanced portfolio like you mentioned above.