Bond ETFs: Is now the time to start investing in the bond market?
With $1.4 billion moving into fixed income ETFs this year, it's now Australia's most popular asset. But how do you actually invest in it?
Fixed income has long been the quiet achiever of the investment world but the latest data shows this is quickly changing – especially so in the exchange traded funds (ETF) space.
Around $1.4 billion of funds have poured into Australian fixed income ETFs since the start of the year, beating the ever popular international equities category for the first time and cementing its spot as our most popular asset, according to the latest report from ETF provider BetaShares.
It means that funds holding global companies such as Facebook and Apple are now less attractive than fixed assets such as government bonds among Australians.
Fixed income typically refers to bonds but it can include cash and term deposit products. Because it's considered a low risk asset, investors tend to use bonds as a safe haven during times of economic unrest and falling interest rates.
Australia is not alone in its splurge of interest in bonds. Last quarter, global fixed income jumped by a massive 61% from the quarter prior, while fixed income ETFs recorded their highest ever inflows, according to BetaShares' Q2 Global ETF Review.
Source: BetaShares / Bloomberg
BetaShares founder and chief executive Alex Vynokur says investors are simply following value and in the last 12 months there's been significant growth in the value of the fixed income space.
"What we’ve seen over the past few quarters in particular is that we’ve really started to see a pretty significant rate of adoption in this market in Australia. So for example, with something as safe as Australian government bonds, where people don’t really expect to get significant returns, it has delivered really significant returns over the last 12 months," says Vynokur.
"People are starting to see that fixed income isn’t just about preservation of capital, it can also deliver positive returns, especially in challenging times that we're facing at the moment in Australia, both with the RBA cutting rates and the trade war."
How are bond products performing?
Bonds have historically been difficult to access for ordinary investors. Many advisers suggest investing no less than around $200,000 in bonds before it starts to pay off. However, the introduction of ETFs into the market means that we can now invest as little as a few hundred dollars into bonds at a time and still see significant returns.
ETFs are essentially a bundle of stocks and other securties (such as bonds) that can be bought and sold like shares on the stock market. To access ETFs you need to sign up with a broker or an online trading platform.
So, how are fixed income ETFs actually stacking up? Below are the highest performing bond ETFs listed in Australia (after fees) over the last 12 months until June 28. As a comparison, Australia's index of top 200 listed companies (ASX200) saw returns of around 11.55% during that time.
ETF fixed-income 10-best performers of 2019
| ASX Code | Type | Fund Name | MER (% p.a) | 1 Year Total Return | |
|---|---|---|---|---|---|
| CRED | ETF | BetaShares Australian Investment Grade Bond ETF | 0.25 | 12.45% | |
| RGB | ETF | Russell Australian Government Bond ETF | 0.24 | 12.01% | |
| IHEB | ETF | iShares J.P.Morgan USD Emerging Markets Bond (AUD Hedged) ETF | 0.51 | 11.73% | |
| IGB | ETF | iShares Treasury ETF | 0.26 | 10.59% | |
| GOVT | ETF | SPDR S&P/ASX Australian Government Bond Fund | 0.22 | 10.52% | |
| BOND | ETF | SPDR S&P/ASX Australian Bond Fund | 0.24 | 10.21% | |
| VGB | ETF | Vanguard Australian Government Bond Index ETF | 0.20 | 10.16% | |
| IAF | ETF | iShares Core Composite Bond ETF | 0.20 | 9.54% | |
| VAF | ETF | Vanguard Australian Fixed Interest Index ETF | 0.20 | 9.50% | |
| PLUS | ETF | VanEck Vectors Australian Corporate Bond Plus ETF | 0.32 | 9.26% |
Source: ASX | June 2019 (MER = management expense ratio, aka fees as a percentage of returns)
The highest performer on the list was BetaShares Australian Investment Grade Bond ETF (CRED), with a return of 12.45% in the year since it was listed, followed by Russell Australian Government Bond ETF (listed in 2012) and iShares' hedged Emerging Markets Bond ETF.
Many of the ETFs listed follow an index of Australian government bonds. So what sets them apart from each other? First, bonds have different durations, which indicates how long it will take for the investor to be repaid the bond in full. The shorter the duration, the less sensitive it is to interest rate movements. So, investors flock to bonds that have durations that match their interest rate expectations over several months or years.
While the returns in the table above aren't beating every other asset class among ETFs – see the full list of the best-performing ETFs in 2019 – these numbers are significant because historically bonds don't outperform the stock markets. In exchange for investing in one of the safest asset classes available, investors understand returns from bonds will be smaller. Although the last 12 months have seen returns jump as bond prices rise, looking over a longer period of three or so years, the same ETFs above have only delivered returns of 4-5%.
Still, should interest rates continue falling, bonds may prove to be the best performing assets in Australia for some time to come.
Read more: How to invest as interest rates fall
Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, options or any specific provider, service or offering. It should not be relied upon as advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for all investors. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades.
