New Nikko AM ETF gives retail investors access to investment-grade corporate bonds

The ETF, which will track the iBoxx SGD Non-­Sovereigns Large Cap Investment Grade Index, a proprietary index developed for Nikko AM, is a much needed product for bond investors.

“We see ETFs as a very important type of product for investors and we’re always looking to widen our suite of products to serve the community better,” says Phillip Yeo, international head of product development and management at Nikko AM.

Nikko AM has two market makers ready to provide liquidity, Flow Traders Asia and Phillip Securities. According to Yeo, they have to “make a market” 85% of the time and must put in both bid and ask trades of $50,000 per trade. Although the maximum bid-ask spread is 2%, it is unlikely to be that wide, Yeo reckons. “With our ABF Singapore Bond Index Fund [ETF], the spread is close at around 30 basis points. Market makers give investors the confidence that someone will take your trade. It’s very comforting to retail investors because it’s easy to buy and sell.”

New investment opportunity

A product such as this should give retail ­investors an investment opportunity not available to many of them before this — investing in top-rated bonds through an ETF. Investment-grade bonds, which are those with ratings ranging from AAA+ to BBB–, are often accessible only to accredited investors.

“In the past, investors would have to [fork out] $250,000 to buy just one issuer. But in this bond ETF, you can have a basket of bonds for as little as $1,000. Previously, it was just private banks, fund managers and institutions that were investing into this market. Now, we can introduce a new type of investor,” Yeo says.

The local bond market is notoriously illiquid, as many investors of high-yield bonds found to their detriment during the oil and gas bond defaults in 2015 to 2017. This year, Hyflux failed to “call” its preference shares in April and also failed to pay the coupon on $500 million of retail perpetual securities.

In particular, retail bonds are sometimes shunned by institutional investors. This is because the credit metrics of the companies that issue them are usually less than sterling. Retail bonds that are currently listed are from issuers such as Aspial Corp and Perennial Real Estate Holdings.

Moreover, in many cases, in particular during the oil and gas bond default, investors — including accredited investors and high-net-worth individuals — did not have access to credit research on many of the issuers of the bonds they invested in. Hence, when these high-yield junk-type bonds were promoted by the bonds’ bookrunners and private banks, ­investors were unaware of the risks involved.

“From an investor’s point of view, it should be about credit discipline. When you invest in these bonds, you should be diversified and you should have analysed the credit capability and the financials of the companies,” says Bertram Sarmago, investment director and portfolio manager at Nikko AM.

Despite the fact that private bankers have a fiduciary duty to provide good advice, it is incumbent on the investor to be responsible for the investment. When a bank is the lead manager of a bond issuance and is promoting the bond to institutional investors, and its private bank is promoting the bond to its clients, the bank is not responsible for the issuer’s poor financials — as was the case for many of the issuances in the last three to four years.

“As institutional investors, we are the ones who will be responsible for our investments, which is why we have a team of portfolio analysts to check the quality of the ‘underlying’ assets. That’s what the bond team does if it’s an active fund,” Sarmago explains.

Screening for quality in the bond market

In investing in Nikko AM’s new ETF, bond investors are unlikely to face the challenges that they had to grapple with during the high-yield fiasco.

“For the ETF, the quality screening is provided by ‘index tracking’”, Sarmago says. As he tells it, the index components are investment-grade — that is, rated from AAA+ to BBB. Some of them are the bluest blue chips such as United Overseas Bank, DBS Group Holdings, Singapore Airlines, CapitaLand and Keppel Corp (see table). The average credit rating is A. For unrated issuers such as SIA and CapitaLand, the index provider calculates an implied credit rating primarily derived from credit spreads and classifies whether the issuer is investment-grade or not, Sarmago explains. The calculations are proprietary to iBoxx but they are likely to consist of conventional credit analysis.

The proprietary Nikko AM iBoxx SGD Non-Sovereigns Large Cap Investment Grade Index will not have any high-yield bonds in its composition. “We have customised this index. We worked with iBoxx, which will maintain the index, but there are no high-yield bonds in it,” Sarmago confirms.

The iBoxx SGD Non-Sovereigns Large Cap Investment Grade Index (created in 2012) comprised $180 billion of bonds. Of this, Singapore government securities (SGS) made up $100 billion, investment-grade bonds $67 billion and high-yield bonds $14 billion. According to Yeo, this index ignited interest in the Singapore bond market.

The proprietary index for Nikko AM’s ETF is modelled on, and yet is different from, the original iBoxx index mainly because there are no SGS and high-yield bonds. The largest allocation is to statutory boards such as HDB and Land Transport Authority. “We carved out the SGD non-sovereign investment-grade bonds, and furthermore, to improve the liquidity of our underlying index, we’ve capped it at $300 million so that the bonds are liquid enough to have a good secondary market. Bonds with a size lower than $300 million will not be in the index,” Sarmago says. The maturity of the bonds must be more than a year; if it is less than a year, the component has to be replaced.

“Our objective is to match as closely as possible the returns of the index. We’ve also capped the issuer limit to match current rules in the Singapore Collective Investment Scheme. For instance, single issuers (of statutory boards) are capped at 20%,” Sarmago says. Bonds of rated corporates are capped at 10% while those for unrated corporates is 5%.

The yield to maturity is 3.22% a year, and the duration of the bonds is 4.68 years. Its expense ratio is a modest 0.3% a year. “Whatever the cost, Nikko AM will cap it at 30bps and bear the rest so that the expenses don’t eat into the returns of the coupon,” Yeo says.

Flight to safety during crises

Of course, no investment is without risk. These are well flagged in the ETF’s prospectus. Among them are market risk and liquidity. Bonds are interest-rate sensitive investments and are likely to fall in price as yields rise. The global economy is in a rising interest rate environment, given growth in the US and inflationary pressures from the US administration’s tariff war, and this could pressure bond prices.

Yeo admits that if there are a lot of redemptions — given the external environment — the fund will sell down the underlying securities.

However, during the global financial crisis in 2008, when interest rates spiked, Nikko AM’s other bond ETF, the ABF Singapore Bond Index Fund, actually performed well. “In 2008, ABF did extremely well because it was a safe haven asset and perceived as a flight to safety,” Yeo says (see Chart 1).

More than 80% of the ABF ETF — which had an asset size of $747 million as at July 24 — comprises SGS, which are the highest-­rated sovereigns globally, while the remainder is made up of quasi-sovereign/supranational bonds such as HDB, LTA and Temasek bonds. Singapore is one of just 10 countries globally and the only Asian one with the highest AAA credit rating awarded by all three major credit rating agencies. The country has retained this status throughout the last 15 years, covering multiple periods of economic crisis, including the Asian financial crisis in 1997 and the global financial crisis in 2008.

Yeo is hoping that if markets turn volatile, or a crisis brews, the new ETF would similarly attract investors who want shelter from the storm.

“For this new ETF, a third of the bonds are AAA-rated. ‘Stat’ boards are 27% and it has a safe haven aspect to it. That’s why we avoided and removed high-yield [bonds] as that is the most stressed sector during market crashes when you don’t have bids for them. The focus on investment-grade would mitigate that risk,” he adds.