Range opens up for fixed income version
Exchange-Traded Funds (ETFs), one of the fastest growing financial products around, are single shares that give the investor the benefit of tracking the whole of an index. They can be traded as easily and simply as any share and settlement is quick and paperless. Amidst falling and uncertain markets, the take up of ETFs has been spectacular. The assets in European ETFs increased by 23 per cent in the first quarter of 2002 alone. According to Morgan Stanley figures, there are now over $112bn dollars in ETFs worldwide compared with less than $10bn as recently as 1997. There are plenty of reasons for this popularity. For one, the consistent performance that index tracking provides – the investor can avoid the boom and bust of outperforming the market one year just to underperform the next. Moreover, there are ETFs available that cover a broad range of country, regional and industry-sector indices, which make ideal building blocks for a wide range of investment strategies. Risks are reduced through the diversification of holding all of the shares in an index, and the low-cost nature of indexation means that annual management fees can be as low as 0.35 per cent per annum. The next stage in the evolution of ETFs will draw on all of these strengths. It is only a matter of time before we see the widespread use of ETFs that offer exposure to bonds – as opposed to the equity ETFs that have fuelled the growth so far. There are already a couple of fixed income ETFs in Canada, for example, and in May, the US Securities and Exchange Commission approved an application from Barclays Global Investors to offer seven fixed income ETFs. The rationale for this belief is that investors, whether aided by a portfolio manager or acting by themselves, appreciate the ability to build their own portfolios, tailored to meet their own individual needs, in a risk-controlled, cost-efficient manner. At the moment, access to bond investing for the individual investor is largely limited to mutual funds. The investor has little choice but to hand over money to a fund manager, accept that fund manager’s investment strategy, and pay the annual management fee that the fund manager demands. Fixed income ETFs could offer an alternative, and it is likely that they will mirror their equity-based cousins. They will use index-tracking techniques, and will be offered across a range of maturities, countries and issuer-types. Because they are likely to track an index, the investor will get diversified exposure. This is particularly important for corporate bonds, where there is a higher risk of a company defaulting on the debt it has issued. In addition, indexation is a low-turnover strategy, which should substantially save on trading costs and should mean that total expense ratios are lower than comparable mutual funds. Bond ETFs will give investors and their advisers much greater flexibility. Investors will know exactly what they are holding and will be able to buy or sell their shares any time the market is open. This will allow the investor to anticipate, or react to, changes in interest rates, concerns about inflation or changes in their own risk/return profile. ETF providers are already busy rolling out bond ETFs in North America. Given the fast-moving pace of the equity ETF market, one can expect to see fixed income ETFs across the world before long. John Demaine is director, iShares
