Bond ETFs Benefit From Narrow Focus

bondsStock exchange-traded funds have been lambasted for slicing the market too narrowly. But with bonds, more precision is what financial advisers need.

Investors turned to fixed-income holdings last year to offset plunging stock values. But while Treasurys held up, municipal and corporate bonds cratered alongside stocks.

This exposed a problem with many basic fixed-income mutual funds: These are often designed as catch-alls, holding all kinds of bonds and making it difficult for investors to gauge risk.

In fund researcher Morningstar Inc.’s “intermediate term” bond fund category, for instance, the 10 best performers had, on average, almost 40% of their holdings in Treasurys and returned about 8.6% in 2008. The 10 worst performers in same category, with only about 6% in Treasury holdings, were down about 30% on average.

ETF firms are aiming to capitalize on that kind of discrepancy, hoping financial advisers are ready to replace all-purpose bond funds they previously bought for clients with a mix of several narrow-focus bond ETFs, an approach that may allow them to calibrate risks more carefully.

“With iShares ETFs, there are no investment-style surprises,” says Christine Hudacko, a spokeswoman for Barclays PLC’s (BCS) recently sold iShares unit. “No one needs more surprises now.”

Investors seem to be responding to the ETF companies’ pitch, having poured about $23 billion into bond ETFs in 2008 and another $10.9 billion in the first quarter of 2009, according to a recent report by Morgan Stanley.

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