This article was originally published in The Australian Financial Review on 18 May 2023 – ‘ETFs used to be boring. Not any more’.
Australian fixed income and cash ETFs are booming like never before. The growth in assets under management of these types of ETFs over the last year has been nothing short of extraordinary, thanks to a perfect storm of inflation, higher interest rates and economic uncertainty.
According to recent data from the ASX and CBOE, cash and fixed interest ETFs have experienced significant inflows over the past year, while equity-focused ETFs have seen much slower growth. In the 12 months to March 2023, Australian fixed income ETFs grew assets by 26%, while cash ETFs grew by over 46%. In contrast, Australian equity ETFs saw modest growth of just over 2% and global equity ETFs only 1%.
|ETF Asset Group by Class||AUM March ‘23||AUM 1-Year AUM|
|12 Month Net Flows|
|Cash ETFs||$3.9 billion||+46%||+$1.2 billion|
|Bonds ETFs||$16.9 billion||+26%||+$3.8 billion|
|Precious Metals ETFs||$4.3 billion||+11%||-$60.1 million|
|Australian shares ETFs||$41.6 billion||+2%||+$4.2 billion|
|Global shares ETFs||$71.5 billion||+1%||+$3.1 billion|
platinum, palladium and silver.
The growth in fixed income and cash ETFs is a reflection of the changing investment landscape, with many investors seeking out safe-haven assets as they become more cautious about the outlook for shares. With the RBA raising interest rates by 3.75% over the past year (from 0.1% to 3.85%), many investors are looking for low-risk, high-yield investments that offer better returns than traditional bank deposits. Fixed income and cash ETFs seem to fit the bill perfectly, offering investors the stability they crave.
Fixed income ETFs (like ASX:IAF) are essentially a basket of bonds that can provide regular income payments, while cash ETFs (like ASX:AAA) provide exposure to short-term, highly liquid cash or money market securities. Both of these asset classes are highly suitable for investors looking for regular income and the liquidity of listed markets.
What’s driving this shift towards fixed income and cash ETFs?
There are a few factors at play.
First, with the recent market turbulence, which has been in part driven by persistent inflation, many investors are seeking out safer investments with returns that offer greater stability.
Second, the interest rate environment has changed significantly over the past year. With central banks around the world raising rates to fight inflation, investors are looking for higher yields on their investments. This has led to a growing gap between bank deposit rates and yields available on cash and fixed income ETFs, making ETFs a more attractive investment option. For example, we recommend clients use the Australian high interest cash ETF (ASX:AAA) which currently pays 3.92% p.a. compared to typical at-call bank deposit rates of under 2%.
Third, cash and fixed income ETFs typically avoid the higher fees that come with actively managed bond funds. According to the latest S&P SPIVA research report, 79% of Australian fixed income managers underperformed their benchmark over the last 10 years after costs. ETFs are tax efficient and help investors to avoid overpaying for active management.
“…many investors are seeking out safer investments with returns that offer greater stability.
Finally, the rise of cash and fixed income ETFs reflects the changing demographics of Australian investors.
As the population ages and moves towards retirement, many investors are looking for low-risk, high-yield investments that can provide them with regular income streams. This trend is common amongst Stockspot clients, too. After a decade of low interest rates, cash and fixed income ETFs are back on the menu as an attractive investment option for these investors, as they provide regular income and have historically been less volatile than equities.
Investing in fixed income ETFs does, of course, come with some risks. While these investments are generally considered to be low risk, there is the possibility that stubbornly high inflation could cause interest rates to rise further which would lead to fixed rate bonds falling in value.
For this reason we advise clients to also hold a 14.8% allocation to the gold ETF (ASX:GOLD) in their portfolios. When inflation is higher, bonds tend to move in the same direction as shares, so they don’t provide much portfolio protection. On the other hand, gold tends to move in the opposite direction to shares. This means that while gold doesn’t produce a yield, it has historically provided strong diversification benefits in periods of higher inflation.
We believe a higher allocation to gold is prudent for investors in the current environment, particularly in a world of higher inflation. Interestingly, despite returning 14% over the last year, the GOLD ETF has experienced net outflows. This suggests that investors are squarely focussed on income-generating ETFs right now.
However, if inflation remains elevated and bonds don’t provide insulation from share market volatility over the coming years, we would expect retail investors and other asset managers to follow us and increase their allocation to gold ETFs.