Passive bond ETFs unlikely to take off, says Singapore CIO

Fixed-income exchange-traded funds must be actively managed to provide returns to rival equity ETFs, says Lim Heong-Chye of APS Komaba Asset Management.

Emerging-market debt may have attracted major investment flows this year, but fixed-income exchange-traded funds are unlikely to gain traction to the same degree as equity ETFs – at least, not if they are passive products, says Lim Heong-Chye, chief investment officer at APS Komaba Asset Management in Singapore.

“[Fixed-income ETFs] are not that successful even in the US,” he says. On the one hand, it is more difficult to create and maintain these products than equity ETFs, he adds, and on the other, passive bond products tend not to provide returns to rival those of ETFs based on other asset classes.

“Bonds are generally traded over-the-counter, and their maturities are always changing,” says Lim. “It's that which makes tracking bond ETFs not that easy, because the underlying is not static.”

He goes on to question why investors would want to buy a fixed-income ETF. “It's a passive product, and yield is currently quite low in fixed-income markets,” says Lim. “Also, how do you define the management fee? From a marketing point of view, is it worthwhile or attractive to launch these products?”

Well-managed equity ETFs can provide 10-20% returns or higher, he says, but it's harder to obtain such performance in the fixed-income market without using active investment strategies, such as active duration, credit or currency strategies.

He says APS Komaba is unlikely to consider issuing fixed-income ETFs. “Unless the size [of such products in terms of AUM] were to become very big, I don't think it's viable,” says Lim.

And yet the global market for fixed-income ETFs is growing faster than that for equity ETFs, though admittedly from a lower base. As of September 30, $209 billion was invested in fixed-income ETFs globally, around a fifth of the $1.181 trillion in the overall ETF market, according to US asset manager BlackRock.

Fixed-income ETF assets under management grew by 25.7% year-on-year to September 30, compared with 10.7% growth in equity ETF AUM and 14% in the overall market.

Moreover, US ETF providers have actively managed emerging-market bond ETFs in the works. WisdomTree Investments, for instance, recently filed with the US Securities and Exchange Commission to launch an actively managed Asia Bond Fund, Emea bond fund and Latin America bond fund.

As for products APS Komaba is considering launching, the firm is planning an Asian local-currency bond fund in the coming months for private banking/family office investors, if there is sufficient demand. Lim says the fund would utilise the track record and capabilities on Asian fixed income it has built over the past few years managing discretionary mandates for central banks and sovereign wealth funds.

How about renminbi bond investment, now that China has moved to start opening that market by liberalising the rules for renminbi trading and settlement in Hong Kong?

Lim says the Chinese government bond market has the potential to match and outstrip its Japanese counterpart – the biggest sovereign bond market in the world. But that will take a while, he adds, as the Chinese government has a lot of issues to iron out, including withholding tax, foreign-currency controls, QFII quotas, strengthening the secondary market, building an interest rate swap market to make the pricing of RMB bonds more efficient, and so on.

An Asian-currency bond market with more potential for foreign investors in the short term is Korea, which is likely to be included in certain global bond indices for the first time in the near future, says Lim. Moreover, Korean 10-year government bonds are offering a yield of 4.5% at present, compared with around 2.5% for US Treasury bonds.

After Korea, Lim also points to Thailand as a bond market he likes, and Indonesia and the Philippines also offer good opportunities for investors not restricted to investment-grade assets. Indonesia 10-year government bonds offer close to a 7% yield, while the Philippine 10-year sovereign bond yield is around 6%.

However, emerging-market sovereign bonds have seen strong inflows in the past year, causing spreads to tighten and yields to fall, so presumably value is harder to come by in these instruments now?

“I don't think the credit spread is overdone,” says Lim. “If the underlying bonds have strong credit fundamentals, the spread will remain narrow and may narrow further relative to US Treasuries.”

He cites as an example the fact that Indonesian and Philippine government bonds have narrowed from over 300 basis points (bp) to below 200bp in the past year, yet prior to the recent crisis they had tightened as far as 100-150bp.

Moreover, he adds, spreads in Korea, China and Hong Kong have narrowed to below 100bp and are likely to remain at that level for a long time, because people see the potential for up-rating of those sovereigns or indeed down-rating of Western countries. “So people feel comfortable holding these good-credit Asian names,” says Lim.

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