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New products in Australian fixed income
This article appeared in the May 2012 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
iShares launches ETFs with investment-grade securities.
By Tom Keenan, iShares
iShares has launched three fixed-income exchange-traded funds (ETFs) on the Australian Securities Exchange. ASX Investor Update asked Tom Keenan, Director, Intermediary Sales, at iShares Australia, about the new funds' key features, benefits and risks.
ASX Investor Update: Tom what are the three funds that iShares has launched, and how do they differ from each other?
Tom Keenan: They are named according to the indices they track. Each holds only investment-grade securities.
- iShares UBS Composite Bond Index Fund (IAF) holds securities from a broad range of issuers. Its management fee is 0.24 per cent per annum.
- iShares UBS Treasury Index Fund (IGB) only holds Australian Commonwealth Government securities. Its management fee is 0.26 per cent per annum.
- iShares UBS Government Inflation Index Fund (ILB) invests in bonds of the Australian Commonwealth and state governments. Its management fee is also 0.26 per cent per annum.
ASX Investor Update: Tom, fixed-income ETFs were first listed on ASX in March this year. What do they do?
Tom Keenan: Australian investors have long understood that ETFs can provide a range of benefits, including diversification, transparency, cost-effectiveness, liquidity and flexibility. This is true whether the investors are seeking opportunities in Australian equities, international equities or commodities. The three new iShares fixed-income ETFs offer investors these benefits as well.
ASX Investor Update: Fixed-income ETFs are very new in Australia. How long have they been around in other countries?
Tom Keenan: iShares launched the first fixed-income ETF in the United States in 2002. Since then the global fixed-income ETF market has grown at a phenomenal rate: at the end of 2011, worldwide assets under management of more than US$257 billion. iShares is the largest provider of fixed-income ETFs overall and manages around 61 per cent of this market.1
ASX Investor Update: If you had to highlight just one of the benefits, what would it be?
Tom Keenan: The liquidity of fixed-income ETFs. One of the key advantages of ETFs is they are liquid in that they are listed on an exchange. They can be bought and sold just like other listed securities. They can be included in an investor's watchlist and systems like other listed securities. This is very different to individual fixed-income securities which, in Australia, can generally only be bought and sold over the counter. In addition, some bonds on issue are scarce, and the minimum investment can be very large; for example, $500,000 or more. As a result, retail investors often find it difficult to access suitable fixed-income securities. However, there is no minimum investment required to trade a fixed-income ETF on an exchange.
ASX Investor Update: Tom, what additional benefits do they offer in comparison with other fixed-income investment options?
Tom Keenan: For a start, fixed-income ETFs are transparent. A full list of holdings for iShares fixed-income ETFs is available on the iShares website as often as daily. An actively managed fund will typically disclose those holdings on a monthly or quarterly basis. iShares fixed-income ETFs make it clear what they are doing, even though the fixed-income market has generally been considered a little opaque. Fixed-income ETFs can help to diversify a portfolio and may provide a low correlation with equities. iShares fixed-income ETFs have no fixed term or lock-up and they distribute income on a quarterly basis.
ASX Investor Update: What about costs?
Tom Keenan: Fixed-income ETFs are very cost-effective. Independent research2 has shown that at least 70 per cent of actively managed funds3 have failed to outperform the benchmark over periods of three years or more, before fees4. Fixed-income ETFs can provide the same effective exposure at a lower cost.
ASX Investor Update: What are the main risks?
Tom Keenan: Risk can take many different forms and investors should always read the Product Disclosure Statement to understand these before investing. Key risks include:
- Interest rate risk. Because of their fixed rate of interest (or coupon), the market prices of most fixed-income securities will fluctuate in line with overall levels of interest rates. When interest rates rise, the price of fixed-income securities fall; conversely, when rates fall, fixed-rate bond prices rise. Falling interest rates may reduce the income, and therefore the distributions, of the fund.
- Credit risk. All bond investments carry credit risk; therefore it follows that an ETF comprising exposure to bonds will also reflect these credit risks. However, we would stress that each of our three funds hold only investment-grade securities.
- The taxation treatment and outcomes relating to fixed-income ETFs may differ from those that relate to other asset classes, such as equities.5
iShares does its best to manage these risks, but as always, investors should do their homework on each product to ensure they understand the risks.
ASX Investor Update: What reaction have you seen to the iShares fixed-income ETFs since launch?
Tom Keenan: There has been strong demand for the new funds as investors have sought more efficient access to Australia's fixed-income markets. The three ETFs have received "Recommended" ratings from Lonsec, one of Australia's top research houses. These ratings indicate Lonsec has conviction that the funds can achieve their objective and, if applicable, outperform peers over an appropriate investment timeframe. Financial Choice, an investment advisory firm that develops model portfolios consisting of term deposits, hybrids, cash and ASX-listed ETFs for its clients, has already made an allocation to the iShares UBS Composite Bond Fund. We expect demand will continue to increase as investors' awareness of fixed-income ETFs grows, and positive ratings affirm the benefits of these funds.
1 Bloomberg and BlackRock, as at 31 December 2011, cited by iShares, The basics of fixed income ETFs, p2.
2 SPIVA Australia - Standard & Poor's Indices versus Active Funds Scorecard, Mid-2011, cited by iShares, The basics of fixed income ETFs, p2.
3 Active management refers to a portfolio management strategy where the manager makes specific investments with the goal of outperforming an investment benchmark index.
4 The time period stated may not accurately depict performance since inception.
5 Fixed Income ETFs, accessed on 11 April 2012.
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