Fixed income researcher BondAdviser has warned that the structure many retail investors use for investment in corporate bonds - exchange traded funds - is flawed, exposing them to high levels of risk and potentially creating instability in the market.
In its latest Monthly Review, BondAdviser says it is cautious about the “pitfalls of non-financial corporate bond ETFs” and that a market-weighted index investment in corporate bonds can be high risk.
“In equity markets, a market weighted index is a representative sample of the most successful companies, with largest being a proxy for most successful. In a bond index, the biggest debt issuers may be most at risk,” BondAdviser says.
Corporate bond ETFs listed on the ASX include BetaShares Australian Investment Grade Bond ETF, Vanguard Australian Corporate Fixed Interest Index ETF, iShares Core Global Corporate Bond ETF and iShares Core Corporate Bond ETF.
They are relatively small funds, with $347 million in the BetaShares fund, $327 million in the Vanguard fund, $276 million in the global iShares fund and $10 million in the local iShares fund.
BondAdviser says that in the current market there has been a dislocation between weak business fundamentals and tight credit spreads, largely due to central bank buying. This week the US Federal Reserve said it would begin purchasing individual corporate bonds, in addition to its policy of buying corporate bonds through ETFs.
BondAdviser says: “In bonds we are looking to maximise yield and minimise risk. Corporate defaults are expected to increase over the next 24 months, so investors should place emphasis on minimising worst-case scenario risk by ensuring principal is repaid.
“In the current environment our view is to be underweight market exposure and associated defaults that may be present, preferencing more concentrated allocation in well analysed and understood securities and issuers.
“We prefer actively managed credit products.”