This article has been written by expert contributor, Tony Kaye, Senior Personal Finance Writer, Vanguard Australia.
Fixed income ETF inflows are running at a record pace as investors focus on higher interest rate returns and offsetting their exposure to share markets.
Investment trends can sometimes be hard to pick. But the huge and ongoing investor cash inflows into exchange traded funds (ETFs) that invest in fixed income securities such as government and corporate bonds is very difficult to miss, let alone ignore.
Fixed income inflows are currently running at a record pace, largely thanks to deteriorating economic conditions that have spurred a spike in interest rates. Higher interest rates are translating into higher fixed income returns for investors.
Over the first half of this year, investors in the United States poured US$99.4 billion (A$144.3 billion) into fixed income ETFs, according to investment research firm Morningstar. Meanwhile, European demand for fixed income ETFs hit record levels as investors added US$36 billion (A$52.2 billion) into listed bond funds.
Australian fixed income inflows also surged over the six months to 30 June 2023, according to data from the Australian Securities Exchange (ASX) and separate data from Vanguard.
Fixed income inflows outpace equities
In Australia, the combined inflows into Australian-listed ETFs that invest bonds exceeded the inflows into ETFs that invest in domestic and global shares over the first six months of 2023. That’s despite the strong first half rally on global equity markets, including on the ASX.
Collectively, investment inflows into Australian and global fixed income ETF products totalled $2.49 billion over the first half, which compared with inflows of $1.56 billion into Australian and global equity ETF products.
Fixed income ETFs that invest in government bond funds with high investment grade credit ratings have been the biggest beneficiaries of the investment activity.
Australian fixed income ETFs took just under 70% of total fixed income inflows in the first half, with products that invest across domestic bonds and other fixed income securities attracting $1.73 billion of cash inflows.
This represented a 65% increase over the Australian fixed income inflows recorded in the first half of 2022. Meanwhile, global bond ETFs received $763 million over the first half, representing a 32% increase over the first half of 2022.
Diversification and income
“Although rising interest rates have created short-term pain for Australian investors, they have helped to improve long-term return expectations for bonds,” says Duncan Burns, Vanguard’s Head of Investments, Asia Pacific.
“While bond prices typically reprice lower when interest rates rise, investors with a sufficient long-term investment horizon will ultimately be better off.
“Investors are also flocking to bonds in their search for diversification and income as yields continue to stabilise (a signal that investors are becoming more optimistic), presenting an attractive alternative to holding cash which has generally underperformed bonds post rate hike cycles.”
ETF uptake continues to grow
The Australian ETF market continued to grow over the first half, with assets under management reaching a record $146 billion at the end of June, up from 143.5 billion at the end of May.
According to the ASX’s 2023 Investor Study, ETFs are “one of the most affordable ways to enter the investment market and diversify holdings”, with 20% of Australia’s 7.7 million on-exchange investors investing in at least one ETF product.
“ETFs have so many in-built benefits that can make investing simpler and more cost effective for all types of investors,” says Mr Burns.
“For example, less than half of Australian investors believe they hold a diversified portfolio, with many not knowing what investments to select nor how to achieve adequate diversification. This is where ETFs can step in and play a critical role, particularly for female investors who were the most uncertain about stock selection.
“The inherent diversification benefits of ETFs – where one trade can provide investors with exposure to not only hundreds of securities, but also to different markets and asset classes – reduces the need for investors to pick and choose winning stocks, and the costs that goes with buying individual securities.
“Education remains a focus for the ETF industry to help boost investor confidence but it’s encouraging to see ETFs growing in popularity amongst retail investors in particular.”
With $45 billion in assets under management for Australian investors, Vanguard remains the largest ETF issuer on the ASX.
Tony Kaye is Senior Personal Finance Writer at Vanguard Australia. In his role, Tony regularly produces topical investment-related articles and educational content designed to help investors make well-informed decisions.
Tony is a former managing editor and financial journalist, and his articles are published in Vanguard’s weekly Smart Investing newsletter and elsewhere.
The above material has been republished with the permission of Vanguard Investments Australia Ltd.