• Bond ETFs offer higher yield with exposure to government and corporate instruments
  • During US recessions long term government bonds tend to be among the best performing asset classes
  • Government bonds may carry interest rate risks while corporate bonds will have greater credit risk

As the global economic outlooks continues to send jitters through mercurial markets, Australian investors are turning to income producing ETFs. In the second of our series on income producing ETFs we look at Australian bond ETFs providing investors with competitive returns.

BetaShares senior portfolio manager Chamath De Silva told Stockhead recession has become a major part of macroeconomic commentary recently.

“It’s in recessionary environment that a lot of investors, particularly those heavily invested in equities may want to gravitate towards government bonds over corporate bonds or credit bonds, just as a better diversifier to equity risk in case corporate earnings collapse,” he said.

“Historically during US recessions long term government bonds tend to be among the best performing asset classes.”

ETF Securities last month launched the first pure play exposure to US Treasuries available in Australia. The new funds are ETFS US Treasury Bond (Currency Hedged) ETF (ASX:USTB) and ETFS USD High Yield Bond (Currency Hedged) ETF (ASX: USHY).

Government bonds offer high yield but interest rate risk

De Silva said Bond ETFs involve moving up the risk ladder from a cash ETF and offer higher yields. Bonds and interest rates normally have an inverse relationship where bond prices fall as market expectations of interest rates rise and vice versa.

“These are exposures that tend to underperform when the outlook for interest rates increase and we saw that in the first six months of 2022 when government bonds went into drawdown because the market started pricing in an interest rate hiking cycle,” he said.

“But you are getting higher yield and income than you would on cash.”

An example of a government-based bond is BetaShares Australian Government Bond ETF – AGVT (ASX:AGVT)

De Silva said AGVT invests primarily in a portfolio of relatively long duration Australian government bonds. Eligible bonds must be AUD denominated fixed-rate bonds and have a term to maturity of between 7 to 12 years.

Corporate bonds offer even higher yield but credit risk

De Silva said the other higher risk investors can take with bonds is credit risk, which also offers a higher income than cash.

“These are floating rate instruments not sensitive to changes to interest rates but they are more sensitive to risk of a recession,” he said.

BetaShares Australian Composite Bond ETF (ASX:OZBD) provides exposure to a diversified portfolio of high-quality Australian corporate and government bonds.

“There’s a lot of government bonds so the interest rate risk dominates in OZBD but there is still some credit risk which is why it has a higher yield than AGVT,” he said.

You can take on elements of both interest rate and credit risk through ETFs like the BetaShares Australian Investment Grade Corporate Bond ETF (ASX:CRED), which provides an exposure to a portfolio of senior, fixed-rate, investment grade Australian corporate bonds.

“You can see how much the yield enhancement is on a product like CRED because you are investing in fixed rate corporate bonds,” De Silva said.

BetaShares Australian Bank Senior Floating Rate Bond ETF (ASX:QPON) tracks the performance of a portfolio of some of the largest and most liquid senior floating rate bonds issued by Australian banks.

BetaShares Australian Major Bank Hybrids Index ETF (ASX:BHYB) provides exposure to a portfolio of listed hybrid securities issued by Australia’s Big 4 banks.

“QPON and BHYB are floating rate credit so there’s no fixed rate exposure, so there’s minimal interest rate risk.”

Other Australian bond ETFs

VanEck head of investments and capital markets Russel Chesler told Stockhead it also has bond ETFs for investors looking for high yield including the VanEck Australian Floating Rate ETF (ASX:FLOT).

“Australian corporate floating rate notes provides protection against rising rates, many are issued by blue chip Australian companies such as the Big 4 banks,” he said.

“FLOT is yielding around 3.5% per annum.”

He said VanEck Australian Subordinated Debt ETF (ASX:SUBD) offers higher yield but more risk.

“For investors comfortable taking additional risk, Australian subordinated debt which sits lower in the capital structure are a higher yielding solution of around 5% and also provide protection against rising rates,” he said.

Major ETF provider Vanguard also offer a suite of Bond ETFs including:

“They range from low to medium risk, according to an investor’s time horizon, and are spread across Australia or international, government or corporate securities,”  a Vanguard spokesperson told Stockhead.

The views, information, or opinions expressed in the interviews in this article are solely those of the interviewees and do not represent the views of Stockhead. Stockhead does not provide, endorse or otherwise assume responsibility for any financial product advice contained in this article.