The 25 fixed Income ETFs: How to assess the field

ASX listed fixed income ETFs grew strongly in 2018 with $1.3 billion in net inflows, ranking third after International and Australian equity ETFs. The total value of fixed income ETFs is over $5.5 billion across 25 ETFs.

For investors thinking about investing or wanting to review fixed income ETF investments, access a spreadsheet reviewing the market by clicking here, and here are a few key points to consider as well. 

Underlying investments

It is important to understand what you are investing in - there are sub sectors in the market with a range of risk and reward characteristics.

The lowest risk being cash and at the other end of the scale, global high yield bond ETFs.

Most bond ETFs will have an allocation to government bonds, as federal and state governments have been big bond issuers. So, many of the funds are very low risk but also have very low returns. To put the return into perspective, the ten year government bond rate is around 2.15 percent per annum.

So, you should understand the percentage allocation to these assets when comparing fixed income ETFs. Some ETFs only invest in government bonds so returns may even be lower than term deposits!

In fact, the largest fixed income ETF is a Betashares Australian High Interest Cash ETF with $1.3 billion in net assets. The fund aims to provide regular income distributions that exceed the 30 day bank bill swap rate after fees and expenses and invests in bank deposits.  Investors don’t need to open a bank account or lock up capital and are paid monthly. It’s a simple strategy even though it doesn’t actually track an index. The fund started in March 2012 and has returned 2.89 per cent per annum since inception.

Assessing yields

When trying to assess performance, don’t make the rookie error of just reviewing the running yield, which is the annual dollar interest payment divided by its market price. Many running yields are attractive showing 3.5 percent or more, but if you are investing for the longer term, then you will need to look at the yield to maturity, which is likely lower. This is the return if all the bonds are held until their maturity dates.

Only three Australian dollar fixed income ETFs have a yield to maturity of over 3 percent - BetaShares Investment Grade Corporate Bond ETF, VanEck Vectors Australian Corporate Bond Plus ETF and the Vanguard Australian Corporate Fixed Interest Index Fund. Quoted yields to maturity were 3.58, 3.20 and 3.00 percent respectively.

An important factor in assessing various options, especially when interest rates are low, is the weighted average term to maturity. A longer dated portfolio will be higher risk, as it’s harder to determine what will happen to companies over a longer term and should pay higher returns to compensate. The relatively new BetaShares Investment Grade Corporate Bond ETF, launched mid 2018 has an average term of 7.4 years compared to VanEck at 5.1 years and Vanguard at 4.2 years.

The three ETFs reference different benchmarks. I’d suggest you do your homework and check the composition of the benchmark and individual holdings in the ETFs, which may also help explain the different yields.

Corporate bond ETFs

The largest two ETFs that include an allocation to corporate bonds and reference the same underlying benchmark, the Bloomberg AusBond Composite 0+ Year Index are the iShares Core Composite Bond ETF and the Vanguard Australian Fixed Interest Index. There is little to separate the two with Vanguard edging out its competitor, showing a higher yield to maturity and running yield.

If these yields seem low, there are two high yield global fixed income ETFs that may be more interesting. Both issued by iShares and track different high yield indices. The running yields and yields to maturity are over 5 per cent per annum. The funds are relatively small with a combined net asset value of less than $40m and a small number of holdings of just 13 and 23 bonds. Ideally in the high yield space you would want better diversification whereas I’d be much happier with smaller numbers of investment grade bonds.

On that note, a newcomer, the BetaShares Australian Bank Senior Floating Rate Bond ETF that has 96.5 per cent invested in 14 low risk senior bank bonds has been doing well. Launched in 2017 it has $392.4m in net assets with a yield to maturity of 2.78 per cent per annum. The remaining 3.5 per cent is invested cash.

As published in The Australian on 12 March 2019