Are you taking the right risks?

Funds that invest in fixed income securities compensate investors for the risks they take on.

Some of these risks are clear, well defined and compensated for, like credit risk and interest rate risk.

Other risks can be murkier and come unrewarded, like valuation, fund liquidity and fund transparency risks.

Finally, there are risks that investors can introduce themselves in security selection, like concentration risk and the risk of high fees eroding returns.

In seeking higher income, capital stability and liquidity throughout the economic cycle, many investors struggle to find compelling portfolio solutions without taking on unwanted risks.

HCRD Interest Rate Hedged Australian Investment Grade Corporate Bond ETF offers investors a unique solution with the aim of providing this trifecta of outcomes without any hidden risks.

Since inception in November 2024 to end April 2024, HCRD’s approach has outperformed, after fees, the major fixed and floating rate benchmarks, and subordinated bank FRNs, and all by some margin (past performance is not indicative of future performance).¹

Also, HCRD has even outperformed the ASX 200 over this (albeit relatively short) period, and with a fraction of the volatility. This reinforces the case that following the recent rate hiking cycle investors may no longer need to stretch out the risk spectrum for liquid sources of income.

Source: Bloomberg. Period 14 November 2022 to 30 April 2024. Betashares Interest Rate Hedged Australian Investment Grade Corporate Bond ETF (HCRD) and Betashares Australian Investment Grade Corporate Bond ETF (CRED) performance is net of management fees. Past performance is not an indicator of future performance.

Risk and return

HCRD is clear in the risk that it takes to derive returns – credit risk. Credit risk explains the additional liquidity and solvency risk of a corporate bond over and above a ‘risk-free’ (government) bond.

HCRD provides exposure to an equally weighted portfolio of up to 50 investment grade corporate bonds selected based on expected returns rather than debt outstanding, seeking to avoid the shortcomings of traditional debt-weighted indices and provide relatively higher returns (HCRD gains this exposure by investing in CRED Australian Investment Grade Corporate Bond ETF .

Market expectations of a US, and global, soft landing provide a constructive backdrop for credit generally as the risks of default and illiquidity can be expected to decrease under these circumstances.

Further to this, Australian investment grade (IG) credit currently offers particularly compelling relative value against global equivalents as Australia is yet to experience the levels of spread compression observed elsewhere.

These factors arguably provide a favorable outlook for HCRD’s investment exposure.

Source: Bloomberg. As at 17-Apr-2024; Credit spreads defined by option-adjusted spreads against equivalent government bonds​. Past performance is not an indicator of future performance.

Typically, an investment in Australian investment grade corporate bonds, which are predominantly fixed rate, also comes with interest rate risk.

Interest rate risk refers to the impact that changes in interest rates and future interest rate expectations have on a bond’s value. Interest rate risk is often referred to as duration, which is the bond’s sensitivity to movements in interest rates.

HCRD hedges out the interest rate risk inherent in its underlying portfolio by shorting Australian government bond futures. In doing so HCRD substantially reduces the greatest source of corporate fixed rate bond volatility (interest rate risk) and maintains the most consistent source of return (credit risk).

By hedging out the interest rate risk of its underlying portfolio (CRED) HCRD has experienced 75% less volatility than it otherwise would have, without sacrificing returns.

Source: Bloomberg. Australian Fixed Rate Corporate Bonds (CRED) represented by Betashares Investment Grade Corporate Bond ETF (ASX: CRED) total return. Australian Fixed Rate Corporate Bonds Hedged (HCRD) represented by Betashares Interest Rate Hedged Australian Investment Grade Corporate Bond ETF (ASX: HCRD). Corporate Bond Yields represented by AUD Australian Corporate BBB 7y yield Index. As at April 2023. Starting date chosen as inception of HCRD on 14 November 2022. Past performance is not an indicator of future performance.

Risk and no return

In seeking out funds offering higher income, capital stability and liquidity, investors can inadvertently take on risks unknown to them that they are not necessarily compensated for.

While liquidity risk already exists and is compensated for at a security level (see credit risk discussion above) certain funds may also come with their own liquidity risk.

Fund liquidity risk is the risk investors will not be able to buy and sell out of a fund at all or at fair value when they need to. Sometimes a fund’s liquidity risks are well defined through lock-up and notice periods.

However, these risks can also be unexpected. For example, during the March 2020 market crash some listed private credit funds traded at significant discounts to their quoted net asset values (NAV). That is, if investors wanted to sell during this time, in some cases they had to do so at almost half the published fair value of the fund.

Source: Bloomberg. Selected Private Credit Fund (Fund) chosen as an Australian closed ended credit income listed investment company and used for illustrative purposes only. The NAV of the Fund is expected to be calculated daily by deducting from the total value of the assets the Fund liabilities. January 2019 to December 2023. The Fund Unit Price reflects the trading price on the ASX. Past performance is not an indicator of future performance.

While HCRD was not in operation during March of 2020, CRED, the fund through which HCRD obtains its exposure, was trading on the ASX. During this period CRED traded at an average discount to NAV of just 2.3% compared to an average discount of 12% in the above closed-ended fund (being the average during March 2020).

The fund in the above graph is also a good example of valuation risk.

Frequently traded fixed income securities, like the investment grade corporate bonds HCRD invests in, are priced daily allowing investors to understand the fair value of their investments.

However, there are other fixed income securities that are not priced by the market, or not ‘marked to market’. Often it is the task of independent valuers appointed by the fund manager that help determine a fund’s NAV when there is no observable market pricing for the underlying assets.

In the above closed-ended fund, valuers saw no reason to mark down the value of its underlying loans during periods of market stress.

Valuers not marking down these securities can lead to unrealistic risk and return characteristics of these funds and leave investors unaware of the potential risks they may be taking on. Often only when a loan has defaulted will the fund reflect its complete write off. In a period of economic uncertainty this can have severe consequences.

The transparency of some active and unlisted funds may also impact investors understanding of the fund’s holdings and its specific investment strategy.

Passive index funds like HCRD disclose their index methodologies and update portfolio holdings daily, thereby providing investors with a comprehensive understanding of their operation. Most active and unlisted funds do not have the same level of transparency.

Without a clear understanding of a fixed income fund’s underlying holdings, investors cannot be certain of relevant counterparties the fund is exposed to.

Similarly, an active unlisted fund’s investment strategy may not be published with a high degree of detail as to how the fund is deriving returns. This may make it difficult for investors to appreciate how the fund can be expected to perform in various market conditions.

For example, the active fund in the below chart discloses to investors that it targets a stable return above inflation over the medium term.

The strategy was very successful in a lower inflation environment and the fund collected significant assets. However, as can be seen in the graph below, as inflation picked up, the fund’s performance began to decline, and the fund experienced greater volatility.

The key message here is a fund’s objective is not a guarantee of its performance. The more an investor understands about a fund the more prepared they may be to understand that fund’s performance potential in different market environments.

Source: Bloomberg. Selected fund chosen as an Australian closed ended fund and used for illustrative purposes only. September 2018 to March 2024. Past performance is not an indicator of future performance.

Betashares Interest Rate Hedged Australian Investment Grade Corporate Bond ETF (ASX: HCRD)

HCRD offers a compelling solution for investors seeking attractive income, a high degree of capital stability and liquidity throughout the economic cycle.

By isolating the appealing credit attributes of Australia’s robust investment grade corporate bond landscape, HCRD has a clearly defined risk and return profile.

HCRD has the additional benefit of being structured as a passive index tracking ETF with regular monthly distributions.

Finally, HCRD is unique in offering Australian investors an effectively floating rate investment grade credit exposure that isn’t concentrated in banks and other financials, and provides a high level of diversification across sectors and industries.

Sector and credit quality comparison of HCRD and Australian benchmark credit FRN and subordinated FRN indices

Source: Bloomberg. As at 18 March 2024. Sector breakdown and credit quality compared (Bloomberg BICS level 2 classification).

For more information, please reach out or visit HCRD’s fund page.

^{1. Compared to major fixed and floating rate benchmarks shown in table. Compared to major subordinated bank FRN index iBoxx AUD Investment Grade Subordinated Debt Mid Price Index.}