In this article, I will provide my personal views and have an open discussion with you on the recently launched bond ETF: Nikko AM SGD Investment Grade Corporate Bond ETF.
1. IOP of an ETF is unlike IPO of a stock
There is no need to rush to subscribe the bond ETF during IOP (Initial Offering Period). For subscription of the bond ETF during the IOP, you will get all units for the amount that you subscribe. This is because ETF is a fund.
The fund manager will create new units of the fund for the investment amount that you put in. There is no need to ballot like IPO of a stock, where there is a limited number of shares for investors to subscribe.
Also, the price movement of an ETF after listing depends on the underlying asset price in the ETF. In this case, it is the price of the bonds that the ETF is holding.
Unlike stocks, where price may be quite volatile after IPO, as there are limited number of shares for subscription and the price movement is largely based on market sentiment for the stock.
2. Bond ETF has no maturity date
If you are buying individual bond, it is most likely that the bond has a maturity date. If you buy the bond at $100, you will get back your capital at $100 on the maturity date. Assuming that there is no default, your capital is guaranteed by the issuer.
However, for bond ETF, as the bond ETF has no maturity date, the only way for you to get back your capital is to sell your holding. The amount of capital that you will get back depends on the price that you sell. Hence, you have no certainty in terms of the return of your capital.
3. Rising interest rate vs Bond Investment
As you know, when interest rates go up, bond prices go down. This is a general statement that you can apply to bond investment. However, it is very much dependent on how you invest into bonds. I am listing down three possible ways for bond investment as follows:
#1. Passive managed bond fund like ETF. There is no maturity on the bond ETF. Assuming that there is no change to other factors, when bond price goes down, the bond ETF price will go down.
#2. Active managed bond fund like unit trust. Fund manager may use derivative to hedge the interest rate risk. Fund price may not be affected by interest rate. One good indicator that you can check is the duration of the fund. Duration is a measurement for sensitivity of the bond fund against interest rate. If the duration is low or negative, the fund price should not be affected by the interest rate. You can find this duration number in the fund fact sheet.
#3 .Buying individual bond with maturity date. Bond price may go down during the holding period if interest rate goes up. But when the bond matures, you will get your capital back at par value.
Thus, unless you sell the bond before the maturity and sell at a lower price, your return should not be affected by interest rate changes.
In the rising interest rate environment, I will prefer to hold bonds with short maturity date. This is because the bond will mature at an earlier date, you can then use the maturity proceeds to invest in bond with higher yield.
#4. Comparison with other low risk investment instruments. At the time of writing, the yields of low risk investment instrument are as follow:
- Nikko AM Bond ETF ~ 3%
- ABF bond ETF = 2.62%
- SSB (10 years holding period) = 2.57%
- CPF OA interest = 2.5%
- Phillip Money Market Fund = 0.96%
Final Thoughts On Portfolio Diversification
As a Certified Financial Planner, I can’t go away from the concept of portfolio diversification.
The investment tool that you should use is depending on your investment objective and existing portfolio exposure. If your existing portfolio is very concentrated on high risk investment like stock, then you may want to allocate some to lower risk instruments like bond.
In the past, we have very limited retail bonds to invest, but with this new bond ETF, you can now diversify your investment to bond.
Do note that in the rising interest rate environment, bond prices tend to go down. This is especially true for lower yield bonds like investment grade bonds.
My current portfolio is about 70% in stocks and 30% in cash. The 30% cash that I have is in Phillip MMF that give about 0.96%. This is my opportunity fund, I will invest from time to time whenever I see the opportunity in the stock market. With this new bond ETF, I may allocate 10% of my portfolio to get better return for my opportunity fund and for portfolio diversification purpose.
That’s all for the article.
Now comment below and tell me what do you think about Nikko AM SGD Investment Grade Corporate Bond ETF.
the fund offers diversification for retailers. if you want to own this and ABF at some percentage then you build your portfolio in some manner for bond exposure. Otherwise the debt market here is tough for many of us retailers. Addition is no fx risk. Agree with you key is know what position this hold within your portfolio.
Hi Louis, may I know what’s the risk for this NIKKO AM Bond ETF? Generally as I know for corporate bond, if the company go bust so as the bond.
Hi Boon Bong,
The risk of this ETF is depending on the underlying bonds in this ETF. in this case, the underlying bonds are all investment grade bond, the risk of these bonds are relatively lower than other bonds.
Refer to here for the underlying bonds:
https://www.nikkoam.com.sg/files/documents/brochures/nikko_am_sgd_investment_grade_corp_bond_etf_brochure.pdf
Regards
Louis
Hi Louis, in the main, I think your article is fair and very helpful for a novice investor like myself. However, I need to clarify your statement: “The amount of capital that you will get back depends on the price that you sell. Hence, you have no certainty in terms of the return of your capital.”. I am a little confused by this statement. I take it that you mean bond ETF is not as liquid and if have to sell, you may not find a market and will have to take a lower price. Unlike holding a bond directly where you are quite sure to get back your full investment on reaching the tenure date.
Hi Joe,
When you want to get back your capital, you will need to sell to the market buyer at buy price.
Do take note that there is a market maker will always buy back your holdings at price close to the NAV (net asset value of the fund). So the buy price will not deviate too much from the NAV even the market is illiquid.
Why I said that the return of capital is not certain is because it is depending on what price you sell. if you sell at lower price during a bad market, your return will be lower or negative (capital loss).
Regards
Louis
Well, good idea to hold cash in short-term money mkts if not deployed. Giving an alternative, there’s a current account offering from a foreign bank that already pays you 80% of 1m-SIBOR which now works out to be approx 120bps. Not a bad idea.
Hi Louis,
How would you view this ETF vs. the Nikko AM Shenton Short Term Bond Fund (S$)?
Both seem to target investment grade short-maturity bonds. Is the main difference that the bond ETF has more govt.-linked issuers?
Fund description:
The investment objective of the Fund is to seek preservation of capital and liquidity and consistent with this objective, to outperform the Singapore Interbank Offered Rate (SIBOR) by investing in a diversified portfolio of good quality, short-term bonds and money market instruments. There is no target industry or sector and the Fund is not country-specific.
Thanks,
Goondu Investor
Hi Louis, would like to clarify this statement – “Fund manager may use derivative to hedge the interest rate risk.”
How would derivatives help in managing interest rate risk for a bond ETF? Given that bonds are already paying fixed coupon, would entering into derivatives affect the coupon/price? For the case of REITS, interest rate swap would effectively hedge against rising interest rates for their underlying loans. What is the underlying for the interest rate derivative in this case?
Hi Louis, would like to clarify your statement – “Fund manager may use derivative to hedge the interest rate risk.”
How would derivative be helpful in mitigating interest rate risk when underlying bonds are paying fixed coupon? For REITs, derivative such as interest rate swaps are used to fixed interest rate of underlying floating loans in rising interest rate environment. But for a fund with a portfolio of bonds, what is the underlying for hedging of interest rate and how would it be helpful for bond price?
Thanks.