Bond ETFs: A Simple and Efficient Bond Investment Option

September 22, 2020

Stocks, bonds, or both? When it comes to investing, you may find yourself in a dilemma.

There is no definitive answer to this debate but the two different asset classes have diverse characteristics that can fulfil your needs.

But what if you are able to invest in a financial product that combines the advantages of both stocks and bonds? Well, here’s the good news – there is a product readily available on the market that has such qualities.

Many investors are not aware of or have not considered Bond Exchange Traded Funds (ETF). This unique financial product combines the benefits of stocks, bonds and funds into one single package – not unlike instant coffee mix!

Before we get excited and dive further into Bond ETFs, let us better understand the characteristics of stocks and bonds.

Characteristics of Stocks and Bonds

When you invest in stocks, you become part-owner of the company, with a stake in the company’s assets, performance, profits, decision-making process etc. However, as a bond investor, you are essentially lending money to the company in return for promised payment of the principal amount at maturity, and an agreed-upon interest payment.

As a result, stocks are seen as a high-risk-high-return asset class while bonds are often regarded as a safer investment option because of repayment of the principal at maturity.

Benefits of Bonds over Stocks

So why do some investors prefer bonds over stocks? Besides being the safer of the two asset classes, there are other reasons that make bonds an appealing option for investors.

1. Variety

There is a wide variety of bonds on the market; from government bonds, quasi-government bonds to corporate bonds. Different bonds are structured differently with differing maturities, coupon rates, coupon payment frequencies and credit ratings.

Below are examples of Singapore bonds that you may be familiar with.

Types of Singapore Bonds

Bonds Description Advantages Disadvantages
Treasury Bills Short-term marketable debt securities issued by Monetary Authority of Singapore (MAS), with maturity of one year or less. – Short-term holding period
– High credit rating
– Can be sold in the secondary markets to other investors by authorized dealers bank
– Investment amount starts from as low as $1000
– Low return
– Zero coupon payment. Sold at a discount to par value, with payment of par value at maturity
Singapore Government Securities (SGS) Longer-term marketable debt securities, with varying maturities, issued by MAS – Different maturities to match the investment horizons of investors
– High credit rating
– Can be sold in the secondary markets to other investors by authorized dealers bank
– Low investment amount of $1000
– Low coupon rates, with a fixed semi-annual payment frequency
Singapore Savings Bond (SSB) 10-year bond issued by MAS and backed by the Singapore Government – High credit rating
– Low investment amount, with minimum subscription amount of $500
– Redeemable any time before bond maturity, with no early redemption penalty
– Low coupon rates, with a fixed semi-annual payment frequency
– Total amount of SSB held across all issues cannot be more than $200,000 for each individual
Quasi-Government Bond Debt securities issued by quasi-Singapore Government entities such as HDB, LTA and PSA – Different maturities to match the investment horizons of investors
– High credit rating
– Higher interest rates as compared to T-bills and SGS
– Sold in denominations of $250,000 and may be inaccessible to general retails investors
Corporate Bonds Debt securities issued by corporations to raise capital for its business activities – Higher coupon rates as compared to government bonds with similar credit ratings to compensate investors for additional risk taken
– Differing credit rating and maturity to match risk profile and investment horizons of investors
– Coupon rates depend on credit ratings of bonds
– Retail bonds can be bought/sold through exchanges
– Retail bonds can be bought for as low as $1000
– Most corporate bonds are transacted Over the Counter (OTC) through banks or specialised brokers.
– Most OTC bonds in Singapore are sold in denominations of $250,000 and only available to accredited investors
– Risk of bond default if corporations are unable to meet debt obligations
– Bond prices susceptible to company’s performance

Source: http://www.sgs.gov.sg/
Source: http://www.sgs.gov.sg/Individual-Investors/Bonds-and-Treasury-Bills/FAQs.aspx
Source: http://www.sgs.gov.sg/savingsbonds.aspx

2. Stable and Predictable Cash Flows

Unlike stocks, which are not obligated to pay dividends; details of coupon rates, payment dates and maturity are usually stipulated at the time of bond purchase.

Bondholders can receive a steady and visible flow of coupon payments to supplement their passive income. Many investors also use bonds as a form of capital preservation as the bond issuer will repay the principal amount at maturity, while receiving coupon payments in the process.

Stocks do not have maturity dates but there is no guarantee that investors can recover the principal amount invested as stock prices may fall below the purchase price.

3. Hierarchy of Claims

In the event of liquidation, bondholders are higher on the priority list concerning claims to a company’s assets over stockholders, thereby increasing the likelihood that they can recover the principal amount invested.

4. Portfolio Diversification and Stabiliser

Generally, bonds have low performance correlation with stocks, making them an excellent asset class to balance higher-risk stocks in a portfolio. In times of market downturn, bonds can deliver steady and predictable cash flows to help investors soften the impact of fluctuating portfolio performance.

An Alternative Vehicle for Investors to Gain Exposure to Bonds

Now that we know what bonds are about, we can introduce you to Bond ETFs.

Other than investing in bonds directly, investors can gain exposure to bonds through Bond ETFs. A Bond ETF is basically a pooled investment vehicle that holds a portfolio of bonds. It aims to track an index of bonds and tries to replicate the index performance. Unlike most corporate bonds, which are traded OTC, Bond ETFs trade on exchanges like stocks, giving them the additional advantage of intraday tradability.

Benefits of Bond ETFs

Even though Bond ETFs and bonds comprise of the same investment principles, the exchange-trading mechanism and fund structure of Bond ETFs offer several advantages over single bond investments.

1. Diversification

With a Bond ETF, you can gain exposure to a portfolio of bonds. In the event of a bond-default, you will not lose the entirety of your investment, as there are other bonds inside the ETF to cover its position and to help you minimise your losses.

2. Liquidity, Flexibility and Ease of Trading

Bond ETFs are listed and traded on exchanges. You can buy or sell Bond ETFs whenever the exchanges are open with a regular brokerage account. It’s as simple as clicking a button!

Prices are transparent and you do not have to source for a specialised bond broker to execute your transaction. Corporate bonds which are traded OTC may be illiquid and inaccessible to investors.

3. Low Barriers to Entry

Most Corporate Bonds which are traded OTC are sold in denominations of $250,000 and are only available to accredited investors.

Bond ETFs can be bought or sold for as low as one board lot on exchanges. They share the same brokerage fees as stocks and represent a good entry point for retail investors intending to add bonds into their portfolio.

4. Rebalancing of Holdings

Bond ETFs do not have maturity dates and investors can hold them indefinitely. At any given time, some of the bonds inside a Bond ETF may be approaching maturity or exiting the age range that the Bond ETF is targeting. Hence, the Bond ETF will continuously rebalance itself to comply with the index objective that it is replicating.

Because Bond ETFs do not have maturity dates, there is a possibility that investors may suffer capital loss if they sell off the ETF at a lower price than they originally bought it for.

Bond ETFs Listed on SGX

There are several Bond ETFs currently listed on SGX:

Singapore Bonds

ETF ABF Singapore Government Bond Index Fund Xtrackers II Singapore Government Bond UCITS ETF Nikko AM SGD Investment Grade Corporate Bond ETF
Stock Code A35 KV4 MBH
Primary Currency SGD SGD SGD
Inception Date 31 August 2005 17 May 2010 27 August 2018
Asset Under Management SGD 1,029.06 Million SGD 137.36 Million SGD 577.49 Million
Expense ratio 0.25% 0.20% 0.27%
Number of Holdings 39 19 113
12 Month Dividend Yield 1.99% Reinvested 1.99%
Dividend Distribution Frequency Annually N/A Annually
Strategy Government Government Aggregate
Geographical Focus Singapore Singapore Singapore

Information Accurate as of 21 September 2020

Global Bonds

ETF iShares J.P. Morgan USD Asia Credit Bond Index ETF iShares Barclays USD Asia High Yield Bond Index ETF ICBC CSOP FTSE Chinese Government Bond Index ETF
Stock Code QL2 and N6M QL3 and O9P CYC and CYB
Primary Currency USD USD RMB
Inception Date 2 June 2011 5 December 2011 21 September 2020
Asset Under Management USD 53.32 Million USD 136.18 Million RMB 4.57 billion
Expense ratio 0.31% 0.52% 0.25% – 0.30%
Number of Holdings 219 217 23
12 Month Dividend Yield 3.76% 6.07% ~2.98% (Indicative)
Dividend Distribution Frequency Quarterly Quarterly Semi-annually
Strategy Aggregate Aggregate Government
Geographical Focus Asia Pacific Region Asia Pacific Region China

Information Accurate as of 21 September 2020

Nikko AM SGD Investment Grade Corporate Bond ETF

Nikko AM SGD Investment Grade Corporate Bond ETF is Singapore first’s Investment Grade Corporate Bond ETF. Investment grade credit rating indicates a low risk of credit default, making Investment Grade Corporate Bonds a relatively safe investment vehicle for investors.

Historically, Corporate Bonds are traded OTC in large notional amounts and are out of reach for most retail investors. With the Nikko AM SGD Investment Grade Corporate Bond ETF, investors can now have easy and low-cost access to corporate bonds.

The Nikko AM SGD Investment Grade Corporate Bond ETF provides investors with:

  • Low-cost Easy Access to SGD Investment Grade Corporate Bonds
  • Diversification of Portfolio Risk
  • Flexibility and Intraday Tradability on Exchange

ICBC CSOP FTSE Chinese Government Bond Index ETF

ICBC CSOP FTSE Chinese Government Bond Index ETF is the first ETF listed on SGX with direct access to China onshore bond market. It is the world’s largest Chinese pure government bond ETF and has an initial Asset under Management (AUM) of over USD 675 million.

China’s bond market, with USD 15 trillion, is the second largest bond market in the world. The inclusion of China onshore bonds into global bond indices is likely to attract about USD 320 billion of inflows into China onshore bond market in aggregate.

The ICBC CSOP FTSE Chinese Government Bond Index ETF provides investors with:

  • Exposure to high quality Chinese government bonds – rated A1/A+ by Moody’s/S&P
  • Higher yield relative to bonds from other major economies
  • Diversification benefits – low correlation of onshore China government bonds vs. other major government bond indices globally

Conclusion

For most retail investors, buying individual corporate bonds is out of the question. Treasury-Bills, SGS and SSB are typically considered as risk-free investments but with lower returns.

Bond ETFs offer variety, diversification, liquidity and price transparency that single bond investments cannot match. All things considered, Bond ETFs are probably a better and more convenient option for investors looking to diversify their portfolio.

Moreover, there are several settlement methods for Bond ETFs listed on SGX. The ABF Singapore Government Bond Index Fund is available via the CPF Investment Scheme (CPFIS). All SGX listed ETFs are eligible for settlement using the Supplementary Retirement Scheme (SRS) Funds.

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About the author

Mr. Joel Lim
ETF Specialist

Joel graduated from Singapore Institute of Management, University of London with a First Class Honours in Business. He was the recipient of SIM University of London’s Top Student Bronze Award in 2017 and was the worldwide examination topper for the “Financial Management” module in 2016. Joel was also commended by University of London for his excellent performance in the 2014 Examinations.

Joel is involved in ETF education, providing trading ideas and support to traders, dealers and fund managers. Joel also works closely with ETF issuers to educate retail investors about new ETFs during the Initial Offering Period.

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