First published in The Australian
This month exchange traded bond units (XTBs) were launched on the ASX as a way for retail investors to buy into the wholesale bond market. Investors buy units in a trust which invests in a single bond
An XTB sounds like the latest model Ford Falcon, but in reality it’s a way for retail investors to access the wholesale bond market.
Launched this month on the ASX, an XTB or exchange traded bond allows investors to buy units in a trust representing ASX50 companies’ wholesale bonds. There are 17 XTBs available that have maturity dates that range from July 2017 for a BHP bond through to November 2020 for a bond issued by Stockland.
Efforts to increase access to the bond market are welcome, as Australians are still under allocated to bonds by global standards and increasing options will help develop the market. Investors can now choose to invest direct or indirect through bond funds, ETFs and now XTB units.
The primary benefit of the XTB units is their very low minimum investment. Theoretically, you could invest in one of the XTBs for as little as $100. The bonds are generally low risk, defensive investments. If you chose to invest in an XTB, the investment will provide a half yearly income and should return $100 face value of the underlying bond at maturity. But it’s important to note XTBs are a unit trust structure which then invests in the underlying bonds.
XTBs allow investors to buy units in sub-trusts that hold single lines of bonds rather than multiple lines of bonds in ETFs. These units pay a distribution that coincides with the interest payments on the bonds which gives a more direct link to income generated by the bond than in a bond fund. In the world of investments, the closer an investor is to direct ownership the more control they have and the less their return is diluted. As with other unitised investments XTBs have the same liquidity and pooled investment constraints.
The 0.40% per annum fee charged by the securities manager on top of transaction costs of the market maker buying and selling the bonds mean returns are lower than buying bonds direct in the OTC market but possibly better than in a managed fund.
An investor has to do a bit of work to determine the return because the yields you can earn are not what are shown on the website. If you use the price shown on the ASX then go back to the XTB website and put it into their calculator, the yield will be less. A comparison of the rates of return on a sample of five bonds with rates FIIG offers revealed that in all cases direct ownership of the same bonds would yield a higher return to investors.
Key to investment is diversification. In terms of constructing a portfolio from the XTBs on offer, all are fixed rate and this concentration is a primary concern. Many of the XTB prices are higher than the $100 bond face value and should interest rates start to increase the price of the XTBs would likely fall and the value of your investment would also fall. But, no matter what happens to interest rates, holding the XTBs to maturity should result in a positive return.
A truly diversified portfolio should also have an allocation to floating rate and inflation linked bonds, to protect a portfolio under various economic conditions.
Investing in bonds through exchange traded funds and managed funds would improve diversity but investors forgo choice and lose the benefits of known income and a maturity date. XTB units provide more transparency however direct bond investment gives you better control and complete transparency.
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