Retail investors can now buy into a financial instrument that's a reassuring option for those looking to grow their money.
IN A move that went under the radar towards the end of last year, the local bourse relaxed one of its regulations to allow fixed-income exchange-traded funds to be listed on the Australian Stock Exchange.
This is kind of a big deal.
An exchange-traded fund is a cheap way of accessing an entire market, or most of the market that counts. An ETF over the ASX/S&P 200 allows you to buy a little bit of each of the top 200 stocks, as measured by market capitalisation, for the bargain price of slightly more than $39 (last time I looked).
A fixed-income ETF will allow you to buy a small chunk of each of the fixed-income securities in an index for a similarly low price.
Exchange-traded products, or ETPs as they are sometimes called, are very popular globally, as you can see by the charts. They have taken off in the US, which accounts for most of the global turnover, but are still rather small here. Asian assets are just a tiny chunk of total assets under management. In terms of turnover, Australia is ranked ninth in Asia with $6 billion, according to a State Street Global Advisors report.
The change in ASX regulations is a big deal for Australia because it will allow another range of ETFs to be added to the growing number on the ASX. It is also important because, previously, it was difficult for any retail investor to buy a small amount of any kind of fixed-income or bond investment.
Bonds are a loan of funds from you, the buyer, to either a corporate or a government for a fixed interest rate and a fixed period of time. In the event of a collapse of the issuer, your bond investment has priority over any equity in terms of what is repaid first.
Also, if you're wondering why you would buy a bond over simply putting your money in a fixed-term deposit with a better rate of interest, it's because as an asset traded on a market, there is the chance that your investment will rise, and fall, in value compared with what you initially paid for it.
A provider of domestic ETFs in Australia is iShares, along with State Street Global Advisors, Vanguard, Russell Investments and Australian Index Investments.
The managing director of iShares Australia, Mark Oliver, says investors shouldn't think of fixed income as a substitute for yield because yield equals risk.
You don't get anything for free, so don't believe anyone promising 20 per cent yield for no risk.
"Firstly, what investors do recognise is the need for a truly defensive asset," Oliver says. "[They need] some defensive nature to their portfolio that is liquid because that's the important part. As the GFC showed, you may have felt you were in a defensive asset class but then you had product freezes."
To get fixed-income exposure you could always buy into a managed fund but, even with a retail fund, you would need a fairly large minimum investment. The fees would be more substantial than for an ETF, too, especially if it was an actively managed fixed-income fund.
There are some difficulties with fixed-income ETFs. Bonds are securities that are traded daily but are not priced on the same market the ETF would be traded on. This means it will take some time before providers are market ready. Not only do they have to establish the infrastructure, they also need individual product approval from
the regulator.
But I wouldn't be surprised if, before the year ends, we have several fixed-income ETFs to choose from on the local exchange, each of which could add valuable diversification to your portfolio.
Follow this writer on Twitter @Money_PennyP.
Frequently Asked Questions about this Article…
What is a fixed-income ETF and how does a fixed income exchange-traded fund work?
A fixed-income ETF is an exchange-traded fund that gives you a small slice of many fixed-income securities (bonds) in an index for a relatively low price. Like other ETFs, it trades on the ASX, is bought and sold like a share, and aims to provide bond exposure without having to buy individual bonds directly.
Why does the ASX allowing fixed-income ETFs matter for everyday investors?
The ASX relaxing its rules to allow fixed-income ETFs makes bond markets more accessible to retail investors by letting them buy small amounts of diversified fixed-income exposure on the local exchange, something that was difficult for small investors before.
How are fixed-income ETFs different from buying individual bonds or a bank term deposit?
Individual bonds are loans to governments or companies that pay a fixed rate and have repayment priority over equity, while term deposits offer a set interest rate from a bank. Fixed-income ETFs pool many bonds and trade on the market, so their value can rise or fall and they offer easier access and liquidity compared with buying single bonds or meeting large minimums for managed funds.
What are the main benefits of using ETFs to get fixed-income exposure?
Fixed-income ETFs provide low-cost, diversified access to a bond market, improved liquidity compared with many bond investments, and a convenient way to add a defensive, liquid asset to your portfolio—often with lower fees and smaller minimums than managed fixed-income funds.
What risks and limitations should investors consider with fixed-income ETFs?
Fixed-income ETFs face some practical difficulties: the underlying bonds are traded and priced on different markets, so ETF providers need new infrastructure and product approval from regulators. Also remember Mark Oliver’s point that yield equals risk—higher yields typically mean higher risk—and market prices can fluctuate.
Who are the main domestic ETF providers mentioned for Australia?
The article cites iShares (and iShares Australia managing director Mark Oliver), State Street Global Advisors, Vanguard, Russell Investments and Australian Index Investments as providers of domestic ETFs in Australia.
Before fixed-income ETFs, how could retail investors get exposure to bonds?
Retail investors could access fixed income through managed funds, but those often required larger minimum investments and came with higher fees—especially for actively managed fixed-income funds—making ETFs an attractive lower-cost alternative.
When can we expect fixed-income ETFs on the ASX and how many might appear?
The article explains providers must build infrastructure and get individual product approvals, but it suggests we could see several fixed-income ETFs listed on the local exchange within the year, each adding diversification options for retail investors.
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