bond etfs

ETF: Investing in a bond ETF

In ETF Blog, Latestby Kristia van Heerden

Discussing a simplified investment philosophy based on this series by Lars Kroijer, we settled on two investment vehicles. The first is an ETF with global exposure. The second is bonds with a time horizon similar to our investment horizon.

For the ETF, the Ashburton 1200 caught our attention because it offers a small amount of exposure to emerging markets (3.7% at the time of writing). Companies in emerging markets have more potential to grow. This is because either they’re not very big to begin with or because people who spend in these economies start off poor, but then become richer and spend more as the economies grow.

Emerging markets are considered risky investment destinations. If the economies fail to grow because of political troubles, there is no money to be made. A catastrophic event like a war can even shrink these economies. It’s worth the risk, however, because companies that grow a lot make more money than companies that have been around for a long time and are already as efficient as they can be. The Ashburton 1200 ETF combines exposure to emerging economies with those of developed markets, which provide stability in a portfolio.

Bonds are more complicated. First of all, an investment horizon of over a decade makes bonds almost obsolete, except as a more risky alternative to cash. When you have a lot of time, you can afford to wait out market movements, as we explain in this article about volatility. Over time, the market makes more money than the interest you can receive on bonds.

Secondly, not all bonds are equally stable or lucrative. Just like investing in companies in emerging markets has more potential risk and reward, so too investing in emerging market bonds can be more risky and more rewarding. Excluding the emerging markets element, South African inflation-linked bonds will be more lucrative for an investor in a country with a lower inflation rate than ours. This investor will benefit from the above-inflation interest as well as any movement above her country’s inflation.

Kroijer advises investing in the highest-rated, most liquid bond in your currency with the same amount of years to maturity as your investment time horizon. With new bond ETFs listing in the near future, choosing the right one might present some complications.

South Africa is counted among the emerging markets economies. The recent ratings agencies downgrades all affect our bonds. They are more risky than developed market bonds, but also pay more interest. Since we don’t ignore regional exposure in our share portfolios, would it make sense to ignore it when we switch out of shares into bonds?

For investors looking for developed market bonds, gaining access to bonds other than our own was a nightmare until RMB’s DCCUSD listed last year. This ETF-like product gives investors access to US Treasury Bills at a 2.5% yield and whatever profit is made on the currency movement.

Lastly, deciding on the right combination of bonds to equities at the right time is difficult. Presumably a longer time horizon means investors can afford less bond exposure overall and possibly more emerging market bond exposure. Once one becomes dependent on income from investments, deciding between a local bond offering and an international one becomes worthy of consideration.

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