Fixed-Income ETFs Attracting Investors

Fixed-income ETFs have expanded their ranks and attracted new investor interest -- iShares Barclays TIPS Bond (TIP) and iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD) are helping protect investors from inflation and provide them with riskier bets.

The ETF industry broke records in the month of July, boasting a worldwide high of $862 billion in assets under management. In the U.S., 706 ETFs from 22 providers have attracted $582 billion as of July 31. National Stock Exchange Data shows that fixed-income ETFs accounted for 86 billion in assets at the end of July.

TIP and LQD are the top two biggest asset gatherers for ETF giant iShares in 2009. Year-to-date, both funds have attracted more than 5 billion in assets.

The corporate bond market has improved dramatically in 2009 as investors regain their appetites for risk. As the spread between Treasuries and corporate bonds tightened, investors looked for ways to get involved in the upswing. Investors have been using funds like the SPDR Barclays Capital High Yield Bond ETF ( JNK) ETF to participate in the surging corporate-debt tide.

Funds like LQD and the aptly named JNK take some of the pressure out of corporate bond investing. Since the funds invest in a portfolio of bonds, investors can access greater liquidity than can be found in markets for single bond issues. Credit risk is still a concern, but having it spread over a portfolio of creditors is less risky than having to depend on one.

On the other side of the spectrum, some investors continue to worry that increased government spending will ultimately result in inflation. TIP invests in inflation-protected securities to protect investors from inflation fears. This fund is an inexpensive way to protect against these concerns and the credit risk on these securities is essentially zero.

Now the number of fixed income ETFs is set to expand further. Bond giant PIMCO recently entered the arena, squarely fixing its sights on iShares. Pimco's 1-3 Year U.S. Treasury Index Fund ( TUZ) is a clear shot across the bow, challenging iShares Barclays 1-3 Year Treasury Bond ( SHY) with its lower price point.

Vanguard, a staple in the mutual fund industry, also recently filed to debut seven bond ETFs. Three of the ETFs are expected to invest in U.S. Treasuries, three in corporate bonds and one expected in mortgage-backed securities.

The difference between these funds will be the price point. PIMCO's first fund, TUZ, has a 0.09% expense ratio compared to SHY's 0.15%. The new funds from Vanguard are all expected to be 0.15%, making the funds comparable to the iShares Treasury options, but cheaper on the mortgage-backed and corporate bond front.

The popularity of fixed-income ETFs underscores the emergence of non-traditional ETF products. While ETFs used to primarily be equities-based tools, the unique structure of ETFs has lent itself to a host of alternative investments. ETNs, which contain debt instead of equity, have succeeded in attracting investors in some cases, notably the iPath India Fund ( INP), while falling on deaf ears in others.

Both leveraged funds and some commodity funds have shunned equities in favor of futures contracts and swaps. Access to the futures markets used to be prohibitively difficult for most investors. Regulators are now asking whether ETFs "should" open up these arenas simply because they can.

When it comes to ETFs, its what's inside that counts. Fixed-income ETFs cover everything from Treasury protected securities to risky corporate debt. As always, investors should consider the contents of the funds they choose before jumping on the bandwagon.

At the time of publication, Dion was long TIP and SHY.

Don Dion is president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.

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