For Retirees, Passive Index-Based Bonds Are the Way to Go

Bonds are integral components in any retirement portfolio. Corporate bonds can carry higher yields than domestic government debt. When it comes to corporate bonds, passive index-based strategies are often the way to go for retirees.

Source: For Retirees, Passive Index-Based Bonds Are the Way to Go

Consider the iShares Broad USD Investment Grade Corporate Bond ETF (USIG).

USIG follows the ICE BofAML US Corporate Index and holds nearly 6,800 bonds, giving it one of the deepest benches in the investment-grade corporate bond fund category.

“Exchange-traded funds tracking indexes that are representative of the broad investment-grade corporate bond market are a solid option for exposure to this asset class,” writes Morningstar analyst Neal Kosciulek. “Portfolios that mimic the contours of this opportunity set and boast low fees have been difficult for active managers to beat. Over the 10 years through June 2020, just 40% of actively managed funds in the corporate bond Morningstar Category managed to survive and outperform the average of their passive peers.”

The Utility of ETFs like USIG

Bond funds hold a collection of debt with varying maturities, buying and selling debt securities to maintain their short-, intermediate-, or long-term strategies. When it comes to bond ETFs, investors should look at the duration, or a bond fund’s measure of sensitivity, to gauge their investment exposure to changes in interest rates, A higher duration means higher sensitivity to shifts in rates.

“Leveraging the wisdom of the crowd through indexing is a sensible approach to gain exposure to large and liquid markets that enjoy active price discovery. The process of buyers and sellers actively negotiating fair prices for assets allows markets to incorporate new information in real time,” according to Morningstar.

USIG’s annual expense ratio of 0.06% per year, or $6 on a $10,000 investment, makes it one of the most cost-effective funds in the category. The fund is a strong option for cost-conscious long-term investors.

The ETF also helps advisors and investors allay liquidity concerns.

“An illiquid market can be fertile ground for mispricing. A market populated by mispriced securities can be target-rich for active managers. Why, then, have actively managed strategies struggled in the investment-grade corporate bond market?,” adds Morningstar. “While there are many factors at play, one of them pertains to the technological advances that have made the bond market more fluid.”

For more on income strategies, visit our Retirement Income Channel.