A Brief Background
Bonds are cited to be one of the essential returns for an investment portfolio. According to Vanguard research, bonds have generated positive returns in 59 out of 67 years, with an average return of 6.3%. This is something investors should not miss out on.
Many bond ETFs are available to investors all over the world. However, it can get complicated when these investors want to trade them in Hong Kong. The main complication lies in how you will trade the ETFs if investing companies like Charles Schwab don’t offer services that allow you to trade funds listed outside your home country.
Many other brokers only offer a free-trade option for American citizens and residents even though they state differently on their website (e.g.Interactive Brokers). If you are a resident or citizen outside America, there is usually a small fee to trade bond ETFs.
Besides these challenges, investors have many options to choose from. Two popular bonds ETFs would be Vanguard Total Bond Market Index Fund and iShares Core U.S. Aggregate Bond ETF.
The latter has a slightly higher expense ratio because it is actively managed, while its expense ratio is 0.10%. They both have outstanding track records with low tracking errors since they invest in U.S. Treasury Bills and Bonds exclusively, reducing risks involved when trading bonds in general.
Keep in mind that investing in bond funds is usually not advisable unless you plan on holding it for at least five years (in some cases longer). The reason for this is that bond funds tend to be more volatile than individual bonds.
Bond ETFs Explained
Bond ETFs are investments that allow you to buy a certain amount of bonds from a specific market at their current price. As long as the investor holds the exchange-traded fund, they will earn interest from it.
This makes them an appealing choice for many people since they can essentially purchase a diversified portfolio without going through all the hassle of buying individual bonds.
However, investing in these securities can have its downsides too.
The biggest drawback is that, unlike individual bonds, your returns aren’t fixed when purchasing a bond ETF but depend on changing market conditions.
This means that the market value of your bond ETF may go up or down, depending on how people are taking leverage positions (through options or futures contracts trading) and on interest rate changes.
So you should be prepared to take into account the effects of volatility before investing in these securities.
The first thing you need to understand is that there are two different types of bond ETFs: physical backed and synthetic backed.
Physical Backed and Synthetic Backed
You will buy a certain amount of physical bonds like T-Bills directly from issuers. In contrast, with synthetic versions, management firms usually use swaps, futures contracts, forward contracts etc., for leverage trading strategies to trade a certain amount of bonds without actually holding them.
It is up to the investor to decide whether they prefer physical backed or synthetic backed ETFs. The latter has been gaining traction in recent years due to its flexibility and transparency since investors can see what’s going on inside the fund at any time.
As a result, more and more people are opting for a synthetic backed bond ETF instead of its physical version nowadays. We are in an era where everything is done online. Even buying and selling your ETFs in Hong Kong can be done online.
Advantages
- It is simple to trade online here.
- There is no need to go through a broker (who charges a commission fee) or via a stock exchange platform (which requires prior knowledge about the market and is not for everyone).
- Able to quickly make trades on your timing without waiting for someone to place your orders for you, which can be beneficial, especially when there is high volatility in the bond markets.
- Lower currency conversion rates as the currency used here is USD instead of HKD (if traded via an exchange platform with USD as the base currency).
- Higher liquidity as more people trade ETFs now.