Fixed income ETFs are just like other ETFs in that they seek to emulate the performance of a correlating index. Additionally, they trade on ASX in the same way as all other ETFs and in some cases can assist investors gain a diversified exposure to a specific asset class.
Fixed income ETFs are issued over a basket of bonds which can be issued by a variety of domestic and international corporates, Australian Commonwealth, State and Territory governments, government treasury corporations and international governments / semi government entities. Typically, the underlying index tracked will have a variety of bonds with varying maturity dates and as one bond matures, it will be replaced by another to ensure there is sufficient diversity in the portfolio being tracked.
Why invest in fixed income ETFs?
In general, cash and fixed income products such as fixed income ETFs, can provide investors with a more reliable income stream with less price volatility than other asset classes such as shares. This is why investing in this asset class is often referred to as defensive. Typically a fixed income ETF will distribute the income earned on a quarterly basis. Fixed income ETFs provide the exposure to an income producing asset class with the additional benefits of an ETF. These ETF benefits include;
Diversification – a fixed income ETF will generally track the performance of a portfolio of bonds reducing the risk associated with an exposure to the performance of a single bond
Flexibility – fixed income ETFs trade on the ASX just like any other share meaning you can buy / sell at any time during the trading day. This is unlike term deposits where the investment typically has to be held until maturity to avoid any penalty
Low cost – ETFs are designed to be a low cost form of investing meaning a greater proportion of your investment is allocated to earning an income
Risks of fixed income ETFs?
There are some differences between fixed income (bond) ETFs and other equities (shares) based ETFs. As most bonds are held until maturity, an active secondary market to buy and sell bonds may typically not be available. This challenge is bigger for corporate bonds than for government bonds. This can at times make it difficult to ensure a bond ETF encompasses enough liquid bonds to track an index without incurring a large tracking error (difference between the index return and the actual return achieved).
Often the ETF issuer will work through the liquidity problem by using representative sampling which simply means tracking only a sufficient number of bonds to represent an index. The bonds used in the representative sample tend to be the largest and most liquid in the index.
There are a number of risks associated with investment in fixed income ETFs. These risks may result in different investment returns and a loss of income or capital value. Some of the risks include;
1) Interest rate movements - can affect the income earned by the underlying bonds of the ETF. Falling interest rates can lead to a decline in income for the fund while an environment of rising interest rates can lead to the price of the bond falling
2) Credit risk – refers to the risk that the issuer of the bonds may fail to pay interest and principal. Typically those bonds issued by the Commonwealth and State Governments carry lower credit risk than other fixed income securities
3) Distributions risk: there is no assurance that an ETF will pay a distribution. Each ETF is reliant on the receipt of coupons and income from its underlying holdings.
4) Taxation risk - the taxation treatment / outcomes may be different to other asset classes such as shares
You should always carefully read the product disclosure statement which provides detailed information related to the ETFs investment objectives, principal investment strategies, risks and costs before deciding to invest or not.
A complete list of fixed income ETFs is available.
Market Makers provide an important role in ensuring that buyers and sellers of fixed income ETFs and can transact. They provide liquidity to the market by providing quotes through the trading day and update their prices to reflect changes in the value of the underlying securities.
ASX offers a Market Making incentive scheme to further promote tighter spreads and more liquidity in the ETF (Exchange Traded Funds) and ETC (Exchange Traded Commodity) markets. Market Making Participants receive Trading and Clearing Fee incentives from ASX when achieving minimum quoting benchmarks on a monthly basis. Each ETF / ETC is assigned a spread and liquidity requirement.
The table found in the following PDF (272KB) shows the Market Makers (MM) that have signed incentive contracts with ASX and the relevant fixed income ETFs.