The smart thing a lot of investors are doing with bond funds

The mutual fund industry had a bad month recently, and mass selling of bond funds was a big part of the story.

Where’d the money flying out of mutual funds in August go? Well, take a look at what happened with exchange-traded funds, notably those that invest in bonds.

There are some very good bond mutual funds from low-cost fund families, and they’re an excellent way to add bonds to a portfolio. But the typical bond fund has fees that are just too high in this era of low interest rates. Bond ETFs are a much cheaper way to hold bonds, and so they’re scooping up money from investors at an odd time.

By historical standards, we still live in a low-rate world. But interest rates are climbing, and that’s bad for bond prices. If you own any type of bond fund, you’ll know what I’m talking about when you look at recent performance. You still need bonds in a diversified portfolio, though. This may explain the rush of money into bond ETFs – exposure to bonds in a convenient fund format, with low fees.

A total of $835-million flowed into bond ETFs in August, while redemptions of bond mutual funds exceeded new investment by $405-million. September sales figures aren’t yet available for mutual funds, but ETF industry numbers show inflows of $652-million into bond funds.

Beyond low fees, a big attraction with bond ETFs is product selection. In August, foreign bond funds were popular, as were corporate bond and ultra-short term bond funds. Because they hold bonds maturing in less than a year, ultra-short funds are well-suited to a rising rate world. The further out a bond’s maturity, the more it will fall in price as rates rise.

There are foreign and corporate bond mutual funds, and short-term bond funds as well. But bond ETFs are easier to deal with as an investor. They’re clearly labelled, and vital stats about holdings are readily available in the fund profiles all ETF companies offer on their websites. The information on bond mutual funds isn’t as comprehensive in most cases, or as easy to find.

ETFs compare well with mutual funds in all categories, but bonds may be where they shine the most. Kudos to investors for recognizing this.

For an overview of well-established on ETFs, check out the 2018 Globe and Mail ETF Buyers’ Guide.