You will be able to compare two bond ETFs and say which risks each one carries.
Read a bond fund factsheet in a fixed order: duration first, then the average credit rating, then the currency and whether it is hedged, then the costs. Check the yield last, once you know where it comes from.
Arjun, an invented investor, opens his broker's list of bond ETFs and finds dozens with similar names: government, aggregate, corporate, high yield, short duration, hedged. He notices that one fund pays a yield nearly twice another's, and his first instinct is to sort the list by yield and pick the top fund. Doing that would have put him in the riskiest fund on the list.
Every bond fund carries two main risks: interest rate risk and default risk. The factsheet shows how much of each one the fund carries, and these are the first two lines to read.
Duration measures interest rate risk. It gives you a rough idea of how far the fund's price moves when rates move. If a fund has a duration of 7, expect a loss of about 7% if yields rise by one point. If the duration is 2, the loss would be about 2% for the same rise. If you might need the money within a few years, duration matters more than any other figure on the factsheet. Lesson 2.3, "Duration", goes over how it works.
The average credit rating measures default risk. Funds that hold mainly government bonds or investment grade bonds have an average rating of A or AA or higher. High-yield funds have an average rating below investment grade, which means BB or lower. As the average rating falls, the yield rises, and more of the fund's bonds are likely to default over time. The rating scale used here comes from Lesson 6.2, "Credit ratings: useful, late and not a guarantee".
When one fund yields much more than another, read these two lines before you look at anything else. A higher yield almost always comes from a longer duration, a lower credit rating, or both. When Arjun checked, his top-yielding fund held global high-yield bonds, so its extra yield came from lower credit quality.
The third line is the currency the bonds are in, and whether the fund hedges that currency. Many bond funds sold in Singapore hold US dollar bonds or bonds in a mix of currencies. When an unhedged fund holds foreign bonds, its value in Singapore dollars moves with exchange rates as well as with bond prices.
To take a made-up case, say the US dollar falls 5% against the Singapore dollar in one year. An unhedged US dollar bond fund would lose about 5% in Singapore dollar terms from currency alone, before any change in bond prices. A currency loss of that kind can be bigger than a whole year's interest.
A hedged fund, often labelled as an SGD hedged share class, uses contracts to remove most of the currency swing. Hedging has a cost, which depends on the gap between interest rates in the two currencies. You won't see it listed as a separate fee, because it comes through as a lower fund return. If you want bonds to be the steady part of your savings, currency swings can easily be larger than the bond returns, and many people prefer hedged funds or Singapore dollar bonds for this reason. "How the economy hits your wallet", lesson 6.4, "Currency risk in foreign investments, hedged and unhedged", covers currency risk and hedging in more depth.
Three costs reduce your return, and you can find all three on the factsheet or the broker's screen.
The expense ratio, also called the total expense ratio, is the yearly fee taken out of the fund's assets. On S$10,000, an expense ratio of 0.2% costs about S$20 a year, and 0.5% costs about S$50 a year (example figures). Fees matter more for bond funds than for share funds, because bond yields are lower and a fee takes a bigger share of the return. The bid-ask spread is the gap between the price you pay to buy and the price you get when you sell. Heavily traded funds usually have narrow spreads, while a thinly traded fund can cost you a noticeable amount on each trade. Tracking difference is how far the fund's return falls short of the index it follows. Fees cause most of it, with trading costs and the way the fund samples the index adding the rest. To check it, compare the fund's past returns with its index's returns over the same period, both of which the factsheet shows.
If you buy through a broker, commissions and platform fees can be added on top of the fund's own costs.
Two funds can both carry the "bond fund" label and still behave very differently. A fund of Singapore government bonds has almost no default risk and moves mainly with Singapore interest rates. A fund of global high-yield corporate bonds can fall sharply in a recession, when companies struggle to pay their debts, and during those periods its price may move more like shares. Because the category name tells you little about this, rely on the five lines (duration, credit rating, currency, hedging, cost) to see what you would actually own.
Arjun shortlisted two funds and built a small table with those five lines as rows and a column for each fund. With the figures laid out in the table, he could plainly see the difference the similar names had hidden. He looked at the yields only after filling in the five rows.
Do the same for two bond ETFs or funds available in Singapore. Draw a small table with duration, credit rating, currency, hedging and cost as rows and one column per fund, and fill it in from each fund's factsheet and your broker's screen. When every row is filled in, compare the yields.
Compare two bond ETFs or funds listed on SGX or offered in Singapore on duration, rating, currency, hedging and cost in a five-row table.
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