Many investors underestimate the size of the fixed income market. Globally, bonds account for nearly twice as much investment as equities while in Australia, the bond market is approximately equal in size to the equity market ($1.5 trillion). The Australian market is split into wholesale and retail segments.
- The Wholesale (also known as Over-the-counter (OTC)) market can only be accessed by a fixed income dealer or broker as securities in this market are not traded on a public exchange. This market is utilised primarily by institutions and minimum face value investments can range from $10,000 to $500,000. Dealers typically hold inventory of a range of fixed income securities and/or have the ability to source securities that are not held. That being said, brokers attempting to locate securities can be timely and as a result, the OTC market is generally less liquid. However, the OTC market is much larger than the listed market and offers a wider range of fixed income securities meet the various investment needs of individuals.
- The Retail Market main consists of listed securities that be traded on the Australian Securities Exchange (ASX). In contrast to the wholesale market, individuals can invest with a smaller minimum investment amount. The increased transparency allows for better informed investment decisions as prices are readily available. However, it is important to note that the retail market is substantially smaller than the wholesale market and dominated by financial issuers (i.e. major banks). These financial institutions tend offer higher risk fixed income securities (often referred to as hybrids). While the yield offered by hybrids is attractive, investors should understand the features of these types of securities before deploying capital.
Up to the point we have focused on direct fixed income investment but investors can also gain exposure indirectly. There are two primary forms of indirect bond investment: managed funds and exchange traded funds (ETFs).
- Managed funds can be either be unlisted or listed and cover a wide range of investment strategies. The fund can invest in multiple assets or a single asset, invest globally or domestically and cover only bonds or include other credit products in portfolio. We therefore recommend that investors undertake careful due diligence before investing into any of these managed vehicles to ensure that your investment objectives are aligned with the investment objectives of the fund. This includes reviewing the fee structure of the fund.
- As the name suggests, Exchange Traded Funds are listed. The main difference between ETFs and managed funds is their passive investment strategies. ETFs track an underlying index and aim to deliver the same return (before costs and taxes are charged). As a result, ETFs tend to engage in minimal active trading relative to managed funds. They are primarily used as a diversification tool in portfolios as investors can gain large exposure to the fixed income asset class with a small upfront investment. Additionally, ETFs can be sold with ease on the exchange in which they trade which limits any liquidity issues. This is also increases transparency in underlying value.