In 2017, RMB launched an ETF-like creature that gave South African index investors access to US Treasury Bonds (USTBs) for the first time. Instead of a right to the assets of the ETF issuer, who holds the underlying shares of an ETF, investors are USTB owners, fair and square. Since inception, this ETF has returned 11.4% with a dividend yield of 1.4%. This level of return is not turning anyone into a millionaire overnight, but the product’s stability might be appealing to risk-averse investors.
Hint: We discuss how bonds work here, here and also here. This is a local bond ETF that works like ordinary ETFs.
Treasury bonds are issued by the Federal Reserve with maturity dates of between two and ten years. Bond holders receive an interest payment every six months until the bond matures. RMB buys and holds the bonds and issues ownership certificates to investors. These certificates can be traded on the JSE, like an ETF. Should your bond mature while you hold your custodial certificate, RMB will buy new bonds with the same maturity date on your behalf. While the bonds are ordinarily sold in $100 increments, the DCCUSD is quoted and settled in rands. Interest earned in dollars is paid out in rands, making this a great option during times of rand weakness.
Interest earned on custodial certificates are liable to income tax. They are, however, not subject to security transfer tax.
To help us better understand an ETF that’s not quite an ETF, we spoke to RMB’s Ebrahim Patel.
– How does a custodial certificate differ from an ordinary share?
A custodial certificate is a certificate listed on the JSE that conveys ownership and/or rights of an underlying asset to an investor. The Dollar Custodial Certificate conveys upon the holder the right to the capital portion of a US Treasury Bond and the right to income from RMB. The holder therefore owns the underlying asset directly, or has a direct right to the asset without any company standing between the holder and the asset. In a traditional ETF, a company buys the asset and then issues shares or debentures that track the value of the underlying asset. The investor does not own the asset directly, but rather has a claim on a company which owns the asset. In times of economic uncertainty and with the focus on risk after the 2008 crisis, custodial certificates offer investors a more direct investment model.
– What level of risk and return can investors expect from US treasury bonds?
Risk as measured by the volatility of the asset, in other words one standard deviation of annual returns is 15%. This makes sense, since the principal driver of risk on the asset is the exchange rate which has a long-term volatility of roughly the same. In contrast, US 10 Year Treasuries have a long term volatility about a third of the currency’s. The return comprises a yield of 2.5% p.a. plus whatever capital gains or losses are made through the exchange rate weakening or strengthening. Should US bonds appreciate in value, this would translate into a capital gain on the security and vice versa. The sensitivity of the DCCUSD to bond yield changes in the US is ZAR 1.30 per basis point per security. That is, a 10 basis point increase in bond yields will result in a ZAR 13.00 loss on the DCC security and the other way round.
– Why can’t US citizens buy these products and how is that process monitored?
It is a US legal requirement. The offering circular alerts all potential buyers of this condition. Should they still proceed to buy the instrument, they will be responsible for any applicable sanction.
– Does the dollar conversion and bond buying process add to the cost of this ETF?
The cost structure on the DCC is simple: for every coupon that the underlying bond pays, RMB takes 0.3% and pays the remainder out to investors as an income stream from RMB. The only cost to the investor is that their income stream from RMB is 0.3% lower than the income stream paid by the US Treasury Bond.
– Can ETF buyers look forward to more international ETF offerings from RMB?
Watch this space.
