How asset allocation is changing

What’s happening is an ongoing investor shift into income-generating defensive assets. In part, this is a reflection of general nervousness among investors about which way returns are heading over the medium term.

Market volatility returned with a vengeance in early 2018, and hasn’t really left us since. Put that all down to rising geopolitical and economic concerns, mostly as a result of actions in the United States but also as a result of the ongoing Brexit crisis and its wider implications for Europe.

Yet there’s also a growing recognition by investors, not only of the importance of portfolio diversification away from pure equities exposures, but also of the need for reliable income streams.

That’s especially important for the growing band of retirees in pension mode, either directly or through a self-managed superannuation fund. There’s also an increasing number of Australians that have stopped working but are ineligible for a full or part pension because they haven’t yet reached the Government’s official retirement age.

They’re needing to generate income for living expenses off their own savings.

So what’s happening on the ASX is a sharp rise in inflows into low-risk exchange-traded funds that are generating steady income streams from either straight cash or from Commonwealth Government bonds.

It’s actually a trend that’s occurring around the world right now, and numbers just coming in from the first quarter of 2019 show fixed income ETFs are continuing to lift their investor assets under management.

Over the last three months, inflows into US fixed income ETFs totalled $US9.2 billion. The Australian number will obviously be a lot lower, but on a percentage basis of total inflows into ETFs here, it’s likely to be quite similar.

In 2018 net inflows into fixed income ETFs were $1.3 billion, taking total assets under management in this ETFs asset class to $5.6 billion. That’s more than 10 per cent of all the assets held in ETFs on the Australian market – which right now is close to $45 billion.

Where most of the ETFs fixed-income money is going in Australia is interesting. By far, the biggest inflows are going into funds that invest solely in cash – that is, into a blend of shorter-term bank savings products that generate steady income streams.

At the top is the BetaShares Australian High-Interest Cash ETF (AAA), which currently holds $1.34 billion in funds and is yielding 2.05 per cent. Its biggest attractions are that by investing in bank deposits it has a very high level of capital security, plus the fund pays out income distributions to shareholders on a monthly basis.

This sets the product apart from standard banking savings accounts, which are tending to offer lower interest returns overall and don’t always pay out monthly contributions.

But the other growing trend among ETF fixed-income investors is allocations into AAA-rated Australian Government bonds and other bond securities. These also provide a high level of capital security, and are generating higher returns than cash.

At the top of the pecking order in terms of assets under management is the Vanguard Australian Fixed Interest ETF (VAF), which has $785 million in funds and has returned 5.98 per cent over the past 12 months. The total return included a 3.14 per cent growth return, and a 2.84 per cent income return.

VAF invests in a diversified portfolio of around 360 securities (bonds) issued by the Commonwealth Government, state government authorities and treasury corporations, as well as investment-grade corporate issuers with a credit rating of BBB- or higher.

Third in the Australian fixed income rankings is the iShares Core Composite Bond ETF (IAF), which currently has $685 million in funds.

IAF also primarily invests in bonds issued by the Commonwealth Government, state-governments, supranational and sovereign agencies and corporate debt issues, but has a small 0.6 per cent allocation to cash.

Over the past year, IAF has returned 5.96 per cent in total, including a 3.51 per cent growth return and a 2.45 per cent income return.

The universe of fixed income and cash ETF products on the Australian market is continuing to grow, and investors now have a choice of 27 different fund products. There’s a lot to take in, and it basically comes down to one’s income-generating needs and, to an extent, to one’s risk profile.

For example, funds investing in solely in corporate bonds have the capacity to generate high returns, but these investments are higher up the risk scale when compare with Government bonds and guaranteed bank savings deposits.

A separate article will follow on the other types of fixed income ETFs available on the ASX, including those investing in Australian corporate securities as well as those with exposures to offshore bond markets.

Another option, of course, is to leave the yield hunt to the investment experts. InvestSMART has a range of income-focused managed funds.

• The InvestSMART Interest Income Portfolio is designed for investors seeking a high level of stability and regular income by investing in domestic and global fixed securities.
  The Portfolio is invested in a blend of 5- 20 Exchange Traded Funds (ETFs), to provide investors exposure to the performance fixed interest assets all managed in the one portfolio.
• The InvestSMART Diversified Income Portfolio is designed to offer investors a sustainable income stream by investing across asset classes, actively managed by our investment team. Having a well-diversified portfolio is a well-known strategy to assist in growing your capital while minimising your investment risks.

You can learn more about all of InvestSMART’s investment products by clicking Invest With Us.