Investing for income or yield is the ‘in thing’ right now. Capital growth over the short term is hard to come by when markets are so volatile so investors are turning their attention to finding ways to earn regular income.
Term deposits and cash accounts are popular as a result, but investors are also looking for alternatives that are low cost, flexible and easily bought and sold.
Which is wherecash and fixed-income exchange-traded funds (ETFs) come in.A new cash ETF from BetaShares and fixed-income offerings from Russell Investments and BlackRock have been launched in response to investor demand for cash and fixed income, and are now being used by financial advisers and direct investors to add diversity to portfolios, provide an alternative to shares and take advantage of high yields.
So how do they work?
ETFs are traded on the ASX.
Instead of putting your money in an actual fixed-income asset, like a bond, you buy a unit in a fixed-income ETF. This means that, along with the other investors in the ETF, you get a little slice in the many different assets the fund has invested in (its ‘underlying assets’). The value of your unit fluctuates with both the performance of the underlying assets and the market demand for units in your fund. Distribution (yields) are generally paid to investors - BetaShares, for example, pays distributions on a monthly basis.
ETFs invest in assets in a way which attempts to mirror a benchmark or index. So as with other types of funds, having units in a fixed-income ETF provides investors with diversified exposure to many underlying assets; one fixed-income benchmark will typically encompass a mix of government bonds, semi-government bonds and corporate bonds.
Bonds are generally considered to be a less volatile investment than equities or currencies so a fixed-income ETF could be a relatively safe investment.“Investors would not be exposed to one borrower, as you would with a single corporate bond or term deposit,” says Anita Daum, head of portfolio management at Tyndall AM.
Fixed-income ETFs can be traded on the ASX during normal trading hours so they’re transparent because you can track theirperformance on a daily basis.And you can quickly buy and sell them.
The iShare and Blackrock offerings invest 100% of their underlying assets in bonds so the value of units traded on the ASX should reflect the price of the bonds.
The BetaShares cash ETF invests completely in deposits with the Big Four Bank and its yield is designed to out-perform the one month bank bill rate.
What are the risks?
The value of your units in a fixed-income ETF can go down. Fixed-income and cash ETFs will be affected by changes in the interest rate. A fall in the interest rate leads to less income for the fund and its investors. If you invest in a fixed-income ETF an increase in the interest rate implies the price of underlying bonds will fall.
Daum says anotherdisadvantage is that investors in most ETFs don’t have an active fund manager to help protect them from any market risks – the ETF tracks the index regardless.
It’s important for investors to look at the product disclosure statement (PDS) of any fixed-income ETF, as each has various types of exposure. For example, Russell Investments gives equal weighting to each fixed-income security, whilst iShares’ products are market-cap weighted.
“In some cases, investors are simply tied to an index benchmark that is market-cap weighted; this means you will have the most exposure to the largest borrower, which isgenerally not optimal for the investor,” says Daum.
The minimum start-up money is $5,000; this might appear costly, but it is expected to attract a wider range of investors to the bond market.
What kind of returns can you expect? It depends on which index the fixed-income ETF is tied to, says Daum.
Daum suggests fixed-income ETFs are suitable if you’ve already read up on the bond market and want exposure to a particularly stable or high-rated index, such as Australian government bonds.
As with any type of ETF, there is always the possibility your ETF provider could go out of business and remember that these products are listed equities so they can be subject to the same short-term price volatility as other equities such as real estate investment trusts and shares.