Putting the income in your portfolio

Christine St Anne  |  10/04/2012Text size  Decrease  Increase  |  

Christine St Anne: A number of fixed income ETFs have already hit the market. Today I'm joined by iShares' Tom Keenan, and financial advisor, Russell Medcraft, who'll both give us an idea about these products and how to use them in a portfolio.

Gentlemen, welcome.

Russell Medcraft: Thank you.

St Anne: Tom, can you give us a rundown about the types of fixed income ETFs you've just launched?

Tom Keenan: Yes, we've launched three. iShares have launched three new fixed income exchange traded funds on to the ASX. There's three ETFs, and all track benchmarks of high quality bonds. By high quality bonds, we're meaning AAA rated Commonwealth of Australia Government Bonds, semi-government bonds, which are essentially state government bonds, and investment grade corporate bonds, so high quality corporate bonds.

St Anne: And with the yield generated from these products, how is that redistributed back to investors?

Keenan: So just like our equity ETFs, our domestic equity ETFs, the fixed income ETFs will pay a quarterly distribution, and that's the way the income is paid out to investors.

St Anne: So, what sort of benchmarks do they track?

Keenan: So as I said, there are three benchmarks associated with the three ETFs that we've launched. The first one to talk about is the UBS Treasury Index, so that is an ETF that is giving an investor pure exposure to AAA rated Commonwealth Government of Australia debt. Remember Australia is only one of a dozen countries left with a AAA credit rating, so the Australian government is viewed as one of highest quality lenders in the marketplace.

We also have an ETF tracking the UBS Government Inflation Linked Bond Index and this is state and Commonwealth Government Inflation Linked bonds, and inflation linked bonds provide investors with a very pure hedge against inflation or a very pure way to protect a portfolio against the long-term corrosive impact that inflation can have on purchasing power over the longer term.

And then there's is the UBS Composite Bond Index, now this is the broadest measure of fixed income in Australia and it's because it includes roughly a third Commonwealth Government debt, roughly a third semi-government debt, which essentially is state government debt, and roughly a third high credit quality corporate bonds. So, it's a much broader measure of the Australian bond market, has a slightly higher yield due to that corporate component and certainly one of the - certainly is the most widely used benchmark by the industry when measuring the performance of the Australian bond market.

St Anne: Russell, as a financial advisor, how do you use these fixed income ETFs in a portfolio?

Medcraft: Well, we develop model portfolios with predominantly these ETFs, term deposits and a bit of cash. We've been using hybrids for the last couple of years quite actively to give us that bit of extra spread, if you like, in a portfolio. But since these have come on to the marketplace, we've now altered our asset allocation, moving out of hybrids into these types of ETFs.

We've been waiting for a while for these to come on to the market, and for a retiree or a person with a self-managed superfund looking at a good income stream, this combined with a good spread of ASX200 or whatever is, I think, an ideal way to get for a lot of retirees; low cost, transparent, and you can pretty much trade these things in and out very, very frequently. But predominantly our clients are retirees that are looking for a high degree of security, so I feel that these give them that high degree of security, but also low cost and the ability to be able to get in and out of the market. So, we don't have those disasters like frozen funds that we had a few years ago.

St Anne: Tom had mentioned the different benchmarks tracked. Can investors use all these ETFs?

Medcraft: A combination of the ETFs and it really all comes back to the client profile; what asset allocation you put together in a model for a client. But I would recommend that you could probably use all of them or a combination of them.

St Anne: Russell, can you just drill down and give us a little bit more of an idea about how this portfolio is allocated?

Medcraft: Good question. A lot of investors over the last number of years have taken up these hybrids vigorously, and we�ve experience the over-subscription even over the last three to four, five months. We�ve found that traditionally they have been substituting fixed interest for hybrids, because they're wanting this extra yield. So, that's what they want. They needed a greater performance in their portfolio, but they're really unaware - they get their higher yield, but they are unaware of the security issues and the risks that they are running and this is what's coming through now. People we find are now substituting - not totally replacing, but substituting some of their hybrid exposure to these sorts of ETFs, these sort of assets to really protect their portfolio against possible downturns and giving them higher - they don't want the volatility, they want the security. So, these are an ideal solution for that.

St Anne: Term deposits continue to attract investor interest, Russell. So, can these fixed income ETFs be used in conjunction with term deposits?

Medcraft: Yeah, we're already finding now that we're - as their term deposits are maturing, we're contacting our clients to have a greater allocation of this sort of asset. We find that they're giving it a little bit extra yield, but also a greater degree of spread because retirees and investors these days really want a great deal of spread across the asset class and across manager and so on. So, I think this part of the market is going to really be a dominant player in the next three to five years to protect against the - as Tom said, the asset allocation in equities, it's like an direct inverse relationship to the equities market, and that's what we're very excited about.

St Anne: Gentlemen, thank you both for your time.

Medcraft: You're welcome.

Keenan: Thank you.


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