Are these the best ASX Bond ETFs to watch?

An ASX Bond ETF is a hybrid of two different financial products: bonds and ETFs. An Exchange Traded Fund (ETF) is simply a basket of assets which provide diversification within a single trade. There are thousands of ETFs on the market covering dozens of asset classes — one of which is bonds, which provide a fixed income to investors.

ASX Bonds ETFs

Typically, an ASX Bond ETF covers a diversified ‘basket’ of bonds. For clarity, bonds can be thought of as a tiny piece of a large loan and are used by governments and corporations as a way of borrowing capital from a large pool of investors over a fixed period of time.

During this time, the government or company will pay interest at a pre-set rate, and then return the original capital to investors when the period ends at maturity. Bonds often pay more interest than savings accounts in order to attract investors.

As an example, if you bought a 5-year bond with an interest rate (coupon) of 5%, and it cost you $5,000, you would then usually receive your interest at fixed points, and then receive your original $5,000 back after five years have passed. It’s worth factoring inflation into this investing decision, which will bite into returns.

Usually, you do have the option of selling your bonds during the five-year period, but the market price can fluctuate depending on the current open market offer — if investors can get a higher rate of interest on a new bond, then your bond will fall in market value. Of course, bonds remain viewed as ‘safe-haven assets’ as they deliver fixed income and you will eventually get your capital back, with bonds issued by governments often considered close to risk free.

Bonds have historically been less popular than shares in Australia, but this is partially because access to the bond market has been limited. Bond ETFs are opening up a new diversification asset, as high-grade bonds tend to rise in value when share prices fall.

There are many factors to consider when choosing a Bond ETF — including the level of diversification, Management Expense Ratio, slippage, long-term performance, liquidity and yield.

An overlooked, yet critical factor, is the credit quality of the issuer of the bond. For example, Australia has the highest-quality AAA rating, while other some emerging economies have the lowest rating D.

The lower the credit quality, the higher the risk of default and losing your investment; the trade-off is that bonds with a worse credit quality tend to pay a higher interest rate. Of course, this paradoxically can also increase the risk to bondholders as the issuer may struggle with high interest repayments.

The takeaway is that bonds with high credit quality and short durations tend to provide greater diversification protection during share market corrections. Poorer credit quality bonds may boast higher yields, but they tend to correlate closer to shares and therefore are often not used to diversify.

Best Bond ETFs to watch

These bonds have been selected as some of the largest on offer in Australia.

1. Vanguard Australian Government Bond Index ETF (VGB)
2. iShares Core Composite Bond ETF (IAF)
3. BetaShares Australian Bank Senior Floating Rate Bond ETF (QPON)
4. Vanguard Global Aggregate Bond Index (Hedged) ETF (VBND)
5. BetaShares Australian Investment Grade Corporate Bond ETF (CRED)

Vanguard Australian Government Bond Index ETF (VGB)

The Vanguard Australian Government Bond Index ETF invests in high credit quality bonds issued by the government of Australia, alongside various Australian state authorities and treasury corporations. Unsurprisingly, this makes for a comparatively low risk ETF with 76.2% of the bonds rated AAA and the remainder AA.

The management fee has also been cut recently from 0.20% to 0.16% — though there are 155 holdings in the ETF, this is arguably still comparatively expensive. Interest is paid out quarterly, with a yield to maturity of 4.45% and an average weighted maturity date of 6.4 years.

While Vanguard does categorize the ETF as ‘low risk,’ it does suggest an investment timeframe of at least three years.

iShares Core Composite Bond ETF (IAF)

The iShares Core Composite Bond ETF — like all iShares ETFs — is managed by Blackrock, the largest ETF manager in the world. It holds 627 bonds, and more than half of its holdings are in Australian government bonds. Like VGB, interest is distributed quarterly, and the fund is rebalanced every month.

IAF is the largest bond ETF in Australia by fund size, boasting nearly AU$2.3 billion in net assets. It has a weighted average maturity of 5.89 years and a running yield of 3.08%. iShares markets the ETF to be used ‘at the core of your portfolio to seek capital stability and pursue consistent income.’

BetaShares Australian Bank Senior Floating Rate Bond ETF (QPON)

The BetaShares Australian Bank Senior Floating Rate Bond ETF provides investors with exposure to a portfolio of senior floating-rate bonds issued by Australian banks. These are debt instruments with interest rates that adjust periodically based on a benchmark rate — the idea is that investors are protected to a degree against rising rates.

However, while the fund focuses on large and liquid bonds predominantly issued by the ‘big four,’ there can be credit risk in bank-issued debt. The average credit rating is AA-, which while still very investible is lower than AAA, AA+, or AA rated bonds. The estimated yield to maturity stands at 4.93%, with an average maturity of 4.28 years.

Vanguard Global Aggregate Bond Index (Hedged) ETF (VBND)

The Vanguard Global Aggregate Bond Index (Hedged) ETF is perhaps the best bond ETF for investors seeking diversification — it boasts a whopping 12, 219 holdings from across more than 60 countries. It seeks to track the Bloomberg Global Aggregate Float-Adjusted and Scaled Index, hedged into Australian dollars before taking into account fees, expenses and tax.

The ETF has a 0.2% management fee with no indirect costs. 45.7% of the bonds are issued from North America — it’s worth noting that while it has an average risk rating of AA-, there are some lower credit quality bonds held in emerging markets. The yield to maturity stands at 4.2%, with a weighted average maturity of 8.8 years.

BetaShares Australian Investment Grade Corporate Bond ETF (CRED)

The Betashares Australian Investment Grade Corporate Bond ETF is, as the name suggests, comprised of corporate bonds. These have credit quality ratings ranging from the top grade AAA to as low as BBB-, but the average rating is BBB+.

As noted above, lower credit quality usually means better interest returns, and CRED is no exception. The yield to maturity stands at a healthy 6.04% with an average maturity of 6.98 years. However, there is a higher than average 0.22% management expense fee, which can make a difference to compound returns over time.

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