Introducing the Global X Australian Bank Credit ETF (ASX: BANK)

Many Australians are familiar with investing in banking shares, particularly the ‘Big Four’, or may use their term deposits. However, there’s another compelling avenue for investors seeking to diversify their portfolios: gaining exposure to the full capital structure of banks, including senior and subordinated bonds, as well as hybrid securities. As Nobel Laureate Harry Markowitz, the father of modern portfolio theory, famously stated, “diversification is the only free lunch in investing.” By exploring this broader spectrum of banking credit securities, investors can potentially enhance their yield profile and add a layer of diversification to their portfolios.

The Global X Australian Bank Credit ETF (ASX: BANK) is an index-based ETF that invests in a diversified portfolio of Australian banking debt across the full capital structure excluding shares. It comprises fixed and floating-rate bonds, senior and subordinated debt (Tier 2 Capital), and hybrid securities (Tier 1 Capital).

Key Takeaways

  • The Australian banks are some of the highest-quality financial institutions in the world. While most Australians access bank securities through shares and term deposits, they may be missing out on the broader capital structure investable universe.
  • Investing in securities such as senior bank bonds, subordinated debt and hybrids may present an attractive yield for investors whilst not taking excessive duration or credit risk. While BANK may have some concentration risk as it only holds credit securities issued by Australian banks, it is well diversified across the capital structure.
  • BANK provides a first-to-market diversified solution enabling investors to combine three different fixed income security types dedicated to Australian banks into one index-based tradable product at a cost-effective rate.

Australian Banks Market Leading Capital Position

Australian Banks are widely considered among the best capitalised and regulated financial institutions in the world. Integral to both the Australian economy and share market, these banks are often regarded as blue-chip entities due to their market tenure, earnings stability and return on investor capital.

The quality of Australian banks continues to elevate, characterised by high levels of capital ratios. A key metric in this regard is the Common Equity Tier 1 (CET1) ratio, which signifies the strength of a bank’s capital base. Banks with a high CET1 ratio are well-equipped to endure financial challenges, making this ratio a crucial gauge of stability and security for depositors and investors. As can be seen in the chart below, Australian banks are market leaders in terms of capital adequacy compared to the globally systematic important banks (GSIBs).

The S&P Banking Industry Country Risk Assessment (BICRA) score evaluates the economic and industry risks within a country’s banking sector, ranking from Group 1 (lowest risk) to Group 10 (highest risk). Recently, Australia’s industry risk improved from 3 to 2, placing it among the lowest risk scores globally, comparable to countries like Canada, Hong Kong, and Singapore. This improvement reflects enhanced regulatory and governance standards within Australia’s banking sector, contributing to a reduction in overall industry-wide risks.

Source: S&P Global Ratings as of April 2024

There are two primary ways for banks to raise money: 1) by selling ownership stakes through shares (equity); or 2) by borrowing money through issuing bonds (debt or fixed income).

Issuing bonds allows banks to access large sums of money without diluting existing ownership. Banks issue bonds to raise additional capital to meet the demand for loans, which often exceeds the funds available from customer deposits. Essentially, banks operate by borrowing money at a certain interest rate through deposits and lending it out at a higher interest rate so that people can purchase homes, cars or start businesses. When the demand for loans surpasses deposits, banks turn to equity or debt capital to fill the gap.

A bank’s capital structure refers to the mix of equity and debt on its balance sheet. In the event of bankruptcy, the capital structure dictates the order of payment and who gets priority. Bondholders, as creditors, have priority over shareholders and are paid first, ensuring they recover their investment before any residual value is distributed to shareholders. When losses occur, equity absorbs them first, protecting bondholders. This hierarchy means bondholders have a higher claim on the bank’s assets.

Access to Higher Yielding Securities

BANK offers a cost-effective solution for boosting income beyond what traditional government bonds and term deposits have offered. With over two-thirds of the Australian bond market dominated by government or government-related securities, many fixed income investors may be overlooking potential yield enhancements available in the rest of the market.

By having exposure to a diverse array of fixed income securities across the capital structure, BANK’s index has historically offered higher yields than term deposits, government bonds and corporate bonds. Recently, the dividend yield of Australian banks and the broader Australian share market has also fallen below the yield generated from a diversified set of Australian credit securities, such as those held by BANK.

As of May 2024, BANK’s running yield stands at 5.9% with a yield to maturity of 5.5%, which presents a favourable comparison to other asset classes.1

The majority of fixed income ETFs in Australia don’t pay income on a monthly basis.2 BANK offers a more regular income stream by providing investors with monthly distributions. Additionally, investors benefit from franking credits in hybrid securities, enhancing the after-tax yield.

How Does BANK Approach Fixed Income Investing?

BANK tracks the Solactive Australian Bank Credit Index, designed to track the performance of AUD-denominated Australian senior and subordinated bonds and hybrids issued by APRA-regulated Authorised Deposit-Taking Institutions (ADIs). Corporate bonds must be rated at least investment grade, have at least $500 million outstanding in value, and have a minimum of one year to maturity at each rebalance date.

BANK provides investors with exposure to the full capital structure of Australian banks excluding shares in the following proportion:

The 40/30/30 portfolio weighting allocation was chosen methodically because it has historically delivered better risk-adjusted returns and a higher yield profile over several years compared to alternative allocations such as market capitalisation and other fixed weighting schemes. This approach provides exposure to securities with potential reasonable yields without taking on excessive market, duration or credit risk. Additionally, maintaining a non-zero but relatively low duration band helps mitigate interest rate risk relative to traditional government bonds. Should interest rates rise, the price of BANK’s index would not move as materially as a traditional government or fixed-rate corporate bond index.

Investors may sometimes have multiple granular and specific allocations within the Australian fixed income sleeve of their portfolios through several funds or ETFs. BANK offers a comprehensive solution that combines these allocations into one diversified vehicle focused on the credit securities issued by the leading Australian banks. This simplifies portfolio management by reducing complexity and enhancing efficiency by streamlining the investment process. Through a systematic, rules-based approach, investors can delegate decisions on allocations such as fixed vs. floating, senior vs. subordinated, and corporate vs. hybrid.

This approach establishes a robust and diversified fixed income pillar within clients’ portfolios as a key strategic long-term holding. As can be seen in the correlation matrix below, BANK’s index has attractive diversification benefits compared to other asset classes including adding a second layer of diversification within the fixed income securities.

Conclusion

BANK provides a cost-effective convenient way for investors to diversify their fixed income exposure while still providing a potentially attractive yield from trusted Australian banks. Positioned uniquely among fixed income ETFs in the Australian market, BANK is a compelling choice for those seeking a stable and diversified fixed income source in their portfolios.

Related Funds

BANK: The Global X Australian Bank ETF (ASX: BANK) invests in a diversified portfolio of Australian banking debt across the full capital structure, comprising fixed and floating-rate bonds, senior and subordinated debt, and hybrid securities.

 

Forecasts are not guaranteed and undue reliance should not be placed on them. This information is based on views held by Global X as at 01/07/2024.

Past performance is not a reliable indicator of future performance.

Diversification does not ensure a profit nor guarantee against a loss. Brokerage commissions will reduce returns. This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results.