By ELEANOR LAISE
September 2, 2007
As fund companies launch a slew of new fixed-income exchange-traded funds, investors are gaining easy access to many slices of the bond market -- but they also have plenty of room for error.
In recent weeks, ripple effects from a meltdown in "subprime" mortgages, which are made to borrowers with shaky credit, have caused trouble for many bond investors. The prices of some mortgage-backed securities and some other risky bonds have dropped. The upheaval has made some financial advisers wary of all but the safest bonds.
That's worth keeping in mind as investors consider some of the newest varieties of ETFs, which resemble index mutual funds but trade like stocks.
The ETF industry, which previously focused largely on stocks, has launched dozens of new bond ETFs this year -- and it hasn't stuck with the safest fare. Many funds that are new or are now in the works are focused on riskier areas like emerging-market debt and high-yield or "junk" bonds, which are generally issued by companies with questionable credit.
Many advisers are urging clients to stick with short-term, high-quality bonds. A number of new ETFs fit the bill, including SPDR Lehman 1-3 Month T-Bill (BIL) and Ameristock/Ryan 1 Year Treasury (GKA).
The new offerings also include longer-term Treasury funds, like the SPDR Lehman Long Term Treasury (TLO), but advisers are more cautious on these bonds. A 30-year Treasury yields about 4.8%, which is lower than the rate on many bank money-market accounts and certificates of deposit. What's more, rates could easily rise in the coming years, which would push down the prices of existing longer-term bonds.
For investors who want a diversified mix of ultra-safe bonds, a useful innovation is on the horizon. According to a recent regulatory filing, PowerShares Capital Management plans to launch "laddered" Treasury ETFs, which let investors spread their bets over a number of bonds with different maturities. But given the risk in longer-term bonds, investors should stick with bond ladders ranging only up to 10 years or so, advisers say.
Several fund firms, including Barclays Global Investors and State Street Global Advisors, are vying to launch the first municipal-bond ETF, according to regulatory filings. Municipal bonds are typically exempt from federal tax and from state income tax in the state where they are issued. Right now, their yields are "really pretty compelling," says Randy Carver, president of Carver Financial Services in Mentor, Ohio.
Investors considering muni vs. taxable bonds need to consider factors like their own tax bracket and state income tax, Mr. Carver says.
While new funds like iShares iBoxx $ High Yield Corporate Bond (HYG) give investors easy access to a more exotic slice of the bond market, advisers urge caution. "The smartest thing is still to be in quality," says Lew Altfest, president of New York investment advisory firm L.J. Altfest & Co. While the "spread" between junk-bond yields and Treasury yields has widened a bit recently, "you're not getting enough of a premium" to take on the additional risk, Mr. Altfest says.
Write to Eleanor Laise at eleanor.laise@wsj.com
