Over the last few years there has been a great proliferation in ETF’s, both in the number and type that are being offered to investors. Indeed, approximately 700 new ETF’s have come into existence since 2010, which has created a much greater access for investors to a wider variety of asset classes.

Since ETF’s trade on a major stock exchange they can, unlike mutual funds, be bought and sold during the trading day at any time.

$188 billion was the net inflow last year of US listed ETF’s, just a hair shy of the record in 2012 of $190 billion, according to Morningstar, a financial research firm. It’s actually not surprising that US equity ETF’s garnered the biggest amount of investment dollars among all ETF categories last year, given the eye-popping performance of the US stock market.

“ETFs are sort of the Amazon.com of the fund world,” said Ben Johnson, Morningstar’s director of passive funds research. “They have had a leveling effect, offering both individual investors and large institutions access to a wide variety of exposures at very low prices.”

Short duration bond ETF’s have increased greatly in popularity because, as experts are quick to note, many fixed income investors have become nervous recently by the prospect of rising rates.

Bank loan ETF’s have also gained favor with investors as they invest in floating-rate bank loans that are made to companies who are rated below investment grade. One reason that investors find them attractive is that, in general, they offer higher yields than corporate and government bond funds as well as protection against rising rates. Floating-rate bank debt is also adjusted periodically as short-term rates rise or fall, making ETFs better than bonds that pay a fixed interest rate or coupon.

ETFs are also closely tied to the flexibility that the offer. For investment advisors, this is a very alluring feature as it allows investors to target very narrow segments of the fixed income and equities markets.

For example, target maturity bond ETF’s invest in bonds that mature in the same year, as well as baskets of bonds that are tied to an index. When their underlying assets reach maturity the funds liquidate, something that appeals to investors who want the certainty and regular income that comes with buying and holding bonds until they mature, as well as gaining greater diversification that would be difficult to achieve on their own.

The funds do not have a guaranteed return however, and investors may well end up getting back less than their original principal if a bonds (or bonds) in their portfolio default, as well as if they cash out before a fund’s expiration date.

Like other types of bond funds however,  target maturity ETF’s of shorter duration are less sensitive to rising interest rates than their counterpart longer maturity ETF’s.

“Because of the way you are able to manipulate small segments of the market, you can build what you want using ETFs,” said Krell of Cassaday & Co. “You can literally pick your exact bond maturities and credit qualities through ETFs.”

Filed under: Investing

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