Corporate Bonds ETF's Vs Corporate Bonds: Which Is Better?

Corporate bonds or corporate bond ETFs - which of the two should you invest in? The only way to find the answer to this question is to understand these two options. Once you know the difference, you will be able to determine which is better suited for you. Let us get started.

Understanding Corporate Bond ETFs

We are talking about two concepts here: corporate bonds and ETFs. Exchange Traded Funds (ETFs) may be new to many. So, first, let us start with the definition of ETFs.

ETFs are a pool of investments. You buy one unit and you get a piece from multiple investments (like a flower bouquet with different flowers in it), offering instant diversification and ease of buying into a particular market sector or investment style.

Next, we look at corporate bonds. They are debt obligations issued by companies to raise capital for their business growth and other purposes. When you buy a corporate bond, you lend money to the company in exchange for interest payments.

Corporate bond ETFs are easy to understand now, right? These are baskets filled with various corporate bonds, offering you a way to gain exposure to the corporate bond market without picking individual bonds.

Corporate Bonds Vs. Corporate Bond ETFs

As you have seen in the previous section, the main difference is how the two are structured: one is a single flower, while the other is a flower bouquet with different flowers. To help you better understand the term, we will cover all the differences between corporate ETFs and corporate bonds. Here are the differences:

• Investment Management: If you want to buy a corporate bond (a single flower), you need to directly purchase a debt security issued by a specific company. On the other hand, through corporate bond ETFs, you invest in a pool of corporate bonds (bouquet) from various companies held and managed by an ETF provider.
• Diversification Angle: Investing in a single corporate bond limits your diversification and exposes you to the risk of that specific company's financial health. By design, Corporate Bond ETFs hold a pool of corporate bonds, spreading your investment across different companies and reducing your risk profile compared to a single bond.
• Maturity: Corporate bonds have a fixed maturity date, and you get your money back at the end of the tenure. Corporate bond ETFs are traded on exchanges. Therefore, they do not mature and typically attempt to maintain a weighted average maturity (WAM) or duration.

WAM is a simple average of the time until each bond in the ETF matures, weighted by the percentage of the ETF's total assets that each bond represents. Duration takes into account both the time to maturity and the coupon payments of each bond in the ETF, weighted by their proportion in the portfolio. It is expressed in years.

• Minimum Investment: Purchasing corporate bonds requires a larger initial investment (though the amount has fallen drastically recently). You can buy corporate bond ETFs with a relatively small investment (a few hundred or less). 

Advantages Of Investing In Corporate Bonds

Do you still have difficulty picking one of the two? We understand; we will make it easier for you by discussing the advantages of both. Here are the top three advantages to investing in corporate bonds:

• Regular Income: Corporate bonds give you the option of regular income as they have interest payments (coupons) at predetermined intervals, providing a steady income stream. This option can be attractive for retirees or those seeking income generation.
• Variety Of Options: The corporate bond market offers a wide range of maturities (from short-term to long-term) and credit qualities (from investment-grade to high-yield). It allows you to tailor your bond holdings to your risk tolerance and investment goals.

Advantages Of Investing In Corporate Bonds ETF

Apart from giving you regular income, here are some other  advantages of corporate bond ETFs:

• Diversification: They hold a basket of bonds from various companies across different industries. It spreads your investment risk. Even if one company defaults, the impact on your overall portfolio is minimized.
• Liquidity: Since ETFs trade on exchanges like stocks, they offer high liquidity. You can easily buy or sell units of the ETF throughout the trading day, ensuring easier entry and exit from the investment.
• Low Minimum Investment: Shares of a corporate bond ETF trade at much lower prices if you compare them to corporate bonds. It allows you to start with a smaller amount and gain exposure to the corporate bond market.

Disadvantages Of Corporate Bonds

Like every other bond, corporate bonds face interest rate risks, credit risks, liquidity risks, etc. Apart from generic risks, other risks associated with corporate bonds are:

• Reinvestment risk: This refers to the potential difficulty of reinvesting the interest payment at a similar attractive rate as the interest rate can fluctuate over time. If rates fall when your bond matures, or you receive a coupon payment, you might have to reinvest the proceeds at a lower rate.
• Industry Risk: If a particular industry experiences a slowdown due to economic factors, technological improvements, or any other reason, the bonds issued by companies in that industry could lose value.
• Complexity: Compared to some investments, corporate bonds can be more complex due to factors like credit ratings, category, duration, yield, etc.

Disadvantages Of Corporate Bond ETFs

The generic disadvantages of bonds are tied to corporate bond ETFs. Other than those, corporate bond ETFs come with the following disadvantages:

• Tracking Error: Let us help you understand this term. If you plan to invest in bond ETFs or any other ETF, you must know it. It refers to the difference between the performance of a bond ETF and its benchmark index. As you know, the goal of a bond ETF is to closely track the performance of a specific bond index. However, due to various factors, the ETF's returns may not perfectly match the index. A higher tracking error means more deviation from the benchmark, and it could result in you missing some potential gains.
• Intraday Price Volatility: Individual bonds have a fixed price until maturity, bond ETFs trade throughout the day on an exchange, and their prices can fluctuate based on various factors. The intraday price volatility can make it difficult to find the exact price at which you buy or sell shares of a bond ETF.
• Low Returns: Most of the corporate bond ETFs available today in India have AAA-rated bonds or Gsecs as underlying assets and hence they offer low returns of ~ 6% - 8%. Thus they do not offer you better risk-adjusted returns.  

Which Is The Better Option - ETFs Or Bonds?

High Yield Corporate Bonds ETFs or Corporate Bonds—do you have the answer now? After the topics covered above, it should be relatively easy for you. There is no universal answer, as the best option will depend on individuals' preferences, financial goals, risk tolerance, and investment horizon.

If you're looking to invest in a product that combines the benefits of both Corporate Bonds and Corporate Bond ETFs, then Basket by Grip could be the perfect choice for you. Baskets are theme-based, high-yield investments in fixed-income securities, offering the diversification of ETFs along with a range of products, including corporate bonds and/or securitised debt instruments (SDIs).

Conclusion

There's no one-size-fits-all answer regarding corporate bonds vs. corporate bond ETFs. Both options have their merits and drawbacks. Before you pick any option, you should research the issuer (the company in the case of an individual bond or AMC issuing ETF) and understand the credit rating, expense ratios, and investment objectives. Follow Grip Invest for more insightful information on fixed income opportunities.

Frequently Asked Questions On Bond ETFs

1. Is it better to buy bonds or bond ETFs?

There is no universal answer to the question. The best choice depends on your individual circumstances. You can make the right choice if you consider your risk tolerance, investment goals, and the time you can dedicate to managing your portfolio.

2. Do bond ETFs hold bonds to maturity?

No, bond ETFs typically do not hold bonds to maturity.

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