Why instos like Axa stay away from fixed income ETFs

Investors evidently like fixed income exchange-traded funds, despite the difficulties in replicating a bond index, but some big asset owners need more convincing if they are ever to invest in them, delegates at the Inside ETFs Asia forum heard on Wednesday.

Currently there are 160 fixed income ETFs in the Asia-Pacific region compared with just 80 in 2016, according to data provided by ETFGI. 

Using passive vehicles for fixed income investing is tricky because there are duration risks and credit risks and the bonds in an ETF have to be actively managed, Jacky Tang, head of portfolio management group at Goldman Sachs private wealth management, said on one of the panels. 

But things have started to change, he said at the forum produced in association with AsianInvestor.

“It looks like [in] the recent development of the ETF space, all these ETF providers ... are (able) to do more direct replicates of [the underlying bonds in] those fixed income ETFs. Also they can adjust the durations by offering different maturities, different credits, and all that,” Tang said.

“The varieties of fixed income ETFs right now in the market allows my approach to construct portfolios with much more flexibilities. As a portfolio manager, the most important thing is flexibilities because when the market change, you want to move things around,” he said.

It was a point reinforced by the representative of one index provider, FTSE, who highlighted the progress made to create more ETF-friendly fixed-income benchmarks.

“We’ve worked with our partners, all sorts of end investors who may be institutions and lifers in the region, whereby we have created a number of fixed income indices that are easily replicable for ETFs and has done very well in the Taiwan market,” Evan Ong, managing director for Asia ETPs and listed derivatives strategy at FTSE Russell, said on the same panel.

However, the day's discussion proved to be one of two halves as Min Lei, director and head for financial risk management for Asian markets at Axa, on the next panel explained why she still hesitates to invest in fixed income ETFs.

ETFs can play a good role in risk mitigation in a portfolio and they are also very liquid, but there is also a mandate mismatch between fixed income ETFs and an insurance company’s liabilities, Lei said. 

Like other insurers, Axa has specific credit rating criteria for the long-tenor bonds. So whenever there is a change in the credit ratings of the underlying bonds, insurers may be prompted to change their ETF holdings when they are not supposed to trade often, she said.

ETF RISKS

That's in addition to the potential for greater tracking error. The investment universe in the fixed income space is much larger than for equities and some fixed-income indices can have up to 10,000 bonds. Replicating this for an ETF product would be too hard as the accumulated transaction costs would be too high, Lei said.

And if an index is market cap-weighted, it tends to tilt towards companies that issue lots of bonds, when these highly leveraged companies are the ones that investors should avoid, she said. 

“These are the question marks in my mind," she said. "I do like having different forms of low-cost products in the market, but it just hasn’t cleared the hurdles to get into.”

For ETFs in general there were other pieces of investment advice from speakers at the forum.

“Don’t just look at the expense ratio, that’s the risk ... because there are also bid-ask spreads [and] commissions," Jackie Choy, director of ETF research for Asia at Morningstar Investment, said.

Tax is another thing to be clued up on, Choy said, because if you trade a US-listed ETF with underlying Asia assets, you are subject to extra tax compared with a Hong Kong-listed ETF. 

ETFs at the end of the day are just a form of investment that cannot mask the differences between markets, Andre Havas, senior parter at CIMalgo AB, reminded the audience.

They are efficient tools for developed markets like the US, say, but for more niche markets it is important to bear in mind the different dynamics and levels of liquidity, he said.

“[An ETF] as a notion can be very simplified in one way but it still caters for a lot of due diligence if you want to use it in a very professional and robust way, which I think some people disregard. It’s not the holy grail of investment,” Havas said.

November 8 is the second day of the Inside ETFs Asia forum. For more details, please visit this link.