bond etf: stock or bond?

Question

I have a question how bond etf works as I can’t understand all the mechanics. When I buy stock, I bet on its price appreciation. I assume higher volatility as it can go up and down but I am free to realize the gain if that comes at any point. It is all about price.

Now there is fixed market: I am committing my investment to some time period to get the return I am promised. I am still allowed to sell the bonds and get even higher returns in case rates go down(I can reinvest in other asset classes if I have realized higher return on those bonds already). The main point is to get guaranteed yield.

What I am confused is how bond ETF work, they are similar to bonds? Is their price like a stock or a bond? Assume it is holding 100 bonds, does it roll every time the bond expires? What happens if some of the bonds default? I am trying to understand how does this relate to stock or bond world and what do I get from it compare to physically buying 100 bonds on my own? If the rates go up and the bonds I hold depreciate at least I can wait until its maturity and get the promised return while with ETF without any additional loss due to price drop. Is ETF more sensitive to rates move in any way?

Answer 1

Bonds ETFs do not have a "face value" or coupon like individual bonds do. There is no guarantee of getting your investment back unlike individual bonds.

A bond ETF will generally have a consistent "dividend" yield that is based off of the interest they receive from the bonds they hold, and possibly some capital gains if they buy or sell bonds. Bond ETFs typically hold bonds of various tenors, so they no not necessarily all "roll" at the same time.

If some of the bonds default, the ETF takes a loss and goes down in value. usually a few default is not catastrophic for an ETF as they hold thousands of bonds.

A bond ETF if generally more an investment (i.e. "a bet on the interest rates of") a particular country or sector, or a strategy. It behaves more like a dividend-paying equity ETF than an individual bond, but with significantly lower volatility (price fluctuation).

An ETF is no more or less sensitive to interest rates fluctuations than an individual bonds, and that sensitivity is indicated by its duration. Yes if you hold a bond to maturity, then interest rate fluctuations do not matter other then the value of the bond going down and eventually going back up to par (or vice versa) as the bond nears maturity. Since ETFs buy and sell multiple bonds, it may realize more of that interest rate impact, but value wise they are not more sensitive.

Note that it is exactly like holding hundreds or thousands of bonds yourself (minus the administration fee). You would get periodic cash flows from coupons, be guaranteed the principal from individual bonds (subject to default risk) but would have to continually reinvest (possibly reducing your yield) when the bonds mature. You might even decide to sell bonds before they mature for various reasons.