Fixed Interest Exchange Traded Funds - look through to the assets to assess the risks

Fixed Interest Exchange Traded Funds (ETFs) are available to those who don't want to invest directly in fixed interest securities.  We recommend you look at such funds the same way you look at individual securities.  Allocate low risk funds to your traditional capital stable fixed interest allocation and higher risk funds to your return seeking portfolio.  How can you tell?  Look through to the assets of the ETF / fund. 

As an example we will look at two Russell ETFs, the Select Corporate Bond ETF (ASX Code: RCB) and the Australian Government Bond ETF (RGB) with data obtained from www.russell.com/au/solutions/exchange-traded-funds/

In our opinion the lower risk fund is the Select Corporate Bond ETF, RCB, because the modified duration, or term, of the underlying assets is only 2.88 years and its assets are high quality senior bonds.  It has returned 5.52% over the past year. 

The higher risk fund, in our opinion, is the Australian Government Bond ETF, RGB, because the term of the underlying assets is 6.2 years, which is too long for a low risk fixed interest allocation.  The assets are of higher quality than those in the Corporate Bond ETF, but it is the term that adds to the risk.  It has returned 13.4% over the past year and there is the evidence of the higher risk.  This return is higher than the 5.52% generated by the RCB ETF.  For a given fall / rise in interest rates you will make / lose more money the longer the term of the assets, whatever the quality of the issuer and type of instrument.  That is the mathematics of fixed interest at work.   

The RCB coded ETF belongs in your low risk fixed interest allocation, the RGB coded ETF doesn't, in our opinion.  The RGB has its place though, as long as you are aware of the risks.

David Bickford

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