Fixed Income Exchange Traded Fund – Benefits and Risks that You Must Know

There are several ways to invest in fixed income market. One of them is investing in Fixed Income ETF. Below are the advantages and the risk of investing in Fixed Income ETF:

Diversification

The underlying asset for fixed income ETF comprises dozens if not thousands of bonds. This will help to diversify your risk of investing in one or few bonds. The diversification benefit for fixed income ETF is not only diversification across different industries or countries, but it also diversify into different credit rating of bonds. This mix credit rating of bonds will help to reduce the concentration risk, which is the risk of investing in one or few bonds and the bonds failed to pay its obligations.

Liquidity

Although individual bonds are traded on the SGX, the trading volumes for most of the bonds are very low. This will reduce your liquidity of trading the bonds. On the other hand, fixed income ETF is relatively more actively traded in SGX as compared to individual bond. Also because of higher trading volume, the buy-sell spread for fixed income ETF is generally lower.

No maturity date

This is the main difference between fixed income ETF and individual bond. As we know, bond has a maturity date. For the fixed income ETF, even though the underlying asset for the ETF is bond, ETF has no maturity date. This is because the ETF will replenish the old bond to a new issued bond when the old bond reaches its maturity date. This is an advantage for investing in ETF as you don’t need to search for new bond to invest when the old bond reaches its maturity date.

Low management fees

Fixed Income ETF has relatively lower management fees as compared to unit trust that investing in the fixed income market.  The management fee is generally lower than 1% for fixed income ETF. The low management fees of ETF as compared to unit trust is because ETF is less actively manage.

Risk (Interest rate risk)

Similar to the other fixed income asset, fixed income ETF is highly correlated to the interest rate. When the interest rate goes up, the price of fixed income ETF goes down. The easiest way to measure the correlation between interest rate and the price of fixed income ETF is by using effective duration. For example, if the effective duration is 5, this means that for every 1% increase in interest rate, the price of fixed income ETF will decrease by 5%.

Examples of Fixed Income ETF listed on SGX

The following are the examples of Fixed Income ETF listed on SGX:

Conclusion

It is advisable to invest in fixed income ETF as compared to investing in individual bond. But do note that fixed income asset will underperform in the rising interest rate environment. However, due to the low correlation between fixed income assets and equities, it is better to have fixed income investment in your portfolio so that you can optimize the risk and return of your portfolio.