Pros and Cons of Bond ETFs

Exchange-traded funds that track stock indices are among the fastest-growing investment products. Investors large and small are attracted by their low costs, liquidity and tax efficiency.

Some big players are betting that bond ETFs will be just as big a hit. So far this year, 19 fixed-income products have been launched, nearly quadrupling the number available in the U.S. to 25.

Last week State Street Global Advisors, a unit of State Street (STT Quote - Cramer on STT - Stock Picks), launched three Treasury bond ETFs, an ETF that tracks inflation-protected securities and another that tracks investment-grade bonds.

Vanguard rolled out ETF share classes of four of its existing bond index funds in February; that followed on the heels of Barclays Global Investors, a unit of Barclays PLC(BCS Quote - Cramer on BCS - Stock Picks), which launched eight bond ETFs in January.

It's easy to see why: Bonds have a big place in most investors' portfolios, but the bond market is much less liquid that the stock market. So individuals who buy and sell bonds in small denominations end up paying a high price in terms of a wide spread between the bid and offer prices.

But bond ETFs may not be the no-brainer that stock ETFs are for so many people. One of the big advantages these baskets of securities offer over mutual funds is that you directly hold the securities that correspond to your shares. So you don't incur capital gains until you sell these shares. By comparison, mutual funds are pooled investment vehicles, and you can incur capital gains whenever the manager sells appreciated securities in this common portfolio.

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