July 23, 2024
Fixed Income

Fixed income ETFs to help strengthen defensive allocations

The rapid rise of private credit as a legitimate and growing part of a client’s diversified portfolio has left many market pundits wondering what role traditional fixed income and so-called defensive yield exposures now play.

Private credit gained appeal in the post-Covid era with low central bank interest rates and non-bank corporate lenders addressing a lending void. While the asset class has unique risk/reward characteristics, it is not the be all and end all of yield generation. Diversifying with income-focused income ETFs, such as dividend, bond, or covered call ETFs, can help add a defensive tilt to retail portfolios.

Financial professionals and advisers play a critical role in helping clients achieve financial security, which is why the unique benefits of income ETFs are noteworthy. These investment tools offer several key advantages that can be particularly beneficial for clients in the accumulation phase or nearing retirement, as they seek to balance income generation with capital protection and overall portfolio risk management.

Here are a few key reasons why income ETFs should be on the radars of financial professionals and advisers and in some cases outshine private credit markets as a legitimate defensive option.

Global Access at Low Cost

Income ETFs provide investors an accessible pathway to diverse income-generating assets globally, all while maintaining cost efficiency. This stands in contrast to the often regionally limited and cost-intensive nature of private credit investments.

Their ability to deliver a broad spectrum of income sources from various markets allows investors to construct well-balanced portfolios that are well-positioned to navigate global uncertainties with stability and at a lower cost point.

Flexible Liquidity

Compared with the more rigid nature of private credit holdings, income ETFs are typically highly liquid, allowing investors to easily trade on an exchange. This feature can present a distinct advantage to retail portfolios that require greater flexibility in accessing their funds, whether due to emergencies or changing market conditions.

This form of agility not only helps to manage risk as a safeguard to unforeseen economic shifts but enables financial advisers to customise portfolios strategically based on the unique needs of each investor, allowing for efficient adaptation or capitalisation of opportunities.

Strong, Stable Yields

Income ETFs have demonstrated a capacity to weather uncertainties and provide stable returns. Using historical default rates as a guide to default expectations, investment grade corporate bonds have a 0.7 per cent likelihood of defaulting over a four-year period according to Moody’s Investors Service Annual Default Study, March 2023.

As interest rates rose globally in response to post-COVID recovery efforts, fixed income ETFs began offering more attractive yields, and potentially stronger value proposition for investors. Bloomberg data show how the Global X’s US Treasury ETF (ASX: USTB) has exemplified this trend, experiencing inflows exceeding half a billion dollars over the past 12 months and becoming one of the most sought-after ETFs in the country.

Further, defensive income options in the form of covered calls have historically demonstrated income-generating capabilities.

Financial professionals and advisers looking for reliable instruments for defensive income strategies can take confidence in the consistent track record of income ETFs over time.

Diversification

While private credit investments can offer diversification beyond traditional asset classes, this can be dampened by liquidity and accessibility restrictions.

Income ETFs, however, hold a diversified portfolio of securities, spreading risk across various assets and sectors, which can help cushion impact. At Global X for instance, our ETFs hold between ten and 500 securities with the number of securities tailored to fit the relevant investment strategy. By holding positions in several securities, income ETFs enhance the breadth and depth of diversification compared to certain private credit offerings. This, in turn, provides investors with a more resilient and balanced approach to navigating market uncertainties.

Private credit strategies often entail a more focused selection of investments, reflecting the nature of private markets where rigorous due diligence is required in assessing individual borrowers. The lack of transparency in private markets may further limit the disclosure of specific holdings. Furthermore, there has recently been a proliferation of product providers into the private credit space. This manager risk needs to be carefully evaluated, particularly in times of credit market distress.

The diversification offered by income ETFs extends beyond asset classes to encompass geographic regions and industry sectors. This broad exposure can help reduce concentration risk and enhance portfolio stability over the long term.

By investing in income ETFs, financial professionals can offer their clients a well-rounded approach to risk management that aligns with their investment objectives and risk tolerance.

The Income ETF Appeal

Recognising the nuanced nature of income ETFs versus private credit is crucial. Private credit investments, with their distinct risk profiles and structures, may offer alternative benefits, such as the potential for capital appreciation. Yet, it is essential to tread carefully, recognising that these benefits may come with a trade-off, including greater illiquidity and risk.

Income ETFs can offer superior liquidity, flexibility, and often higher yields, making them compelling alternatives. In today's unpredictable economic climate, the resilience and adaptability of income ETFs make them a strategic choice for advisers seeking reliable defensive income tools in client portfolios. Be sure to always consider which kind of income ETFs are most appropriate to meet individual risk and investment needs.

Leave a Reply

Your email address will not be published. Required fields are marked *