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Top Yielding ETFs

As the American economy continues to sputter and the European crisis remains in the spotlight, heavy bond investments in either area seems like an unwise proposition. Yields remain pathetically low on U.S. debt while European securities are all over the place; German bonds offer next to nothing for payouts while peripheral nations are spitting out impressive coupon payments but face significant risks from a capital preservation perspective. Given these realities, many investors have decided to look to other regions for their bond exposure, helping to diversify holdings in this key component of a portfolio.  

Unfortunately, options remain limited for those focusing in on developed markets. Canada remains heavily tied to the U.S. while Japan has budget issues of its own and isn’t exactly paying out double-digit yields either. Other Asian nations, such as Singapore or Hong Kong, remain much too small for huge investments, leaving many investors with only one option; Australia.

Australia, and to an extent New Zealand as well, represent a large market for developed market investors in a relatively strong and uncorrelated region of the globe. The area remains a commodity powerhouse, has low exposure to the European debacle, and Australia is rated AAA by all the major issuers. While one might think that a region with such fundamentals have extremely low yields, this isn’t really the case as both Australia and New Zealand have benchmark rates far higher than those in other corners of the developed world. In fact, Australia’s benchmark rate is a whopping 4.5%, 18 times higher than the current rate in the U.S.  (see German Bond ETFs In Focus)

This reality has led to a new push by ETF issuers to offer greater exposure to the space and has resulted in the recent launch of two Aussie-bond focused funds for American investors. These two funds, AUNZ and AUD, while still brand new, could see a great deal of inflows as investors move towards higher yielding, but still extremely safe, securities in the developed world. Furthermore, the funds could interest from those looking to escape the European crisis to an extent or those that are just looking to spread bond assets around in the same way that they already do with their equity holdings (see Top Three High Yield Real Estate ETFs).

For these investors, a closer look at the two options is necessary as both products have several similarities including a related focus as well as the same expense ratio of 45 basis points. Yet while they might seem similar on the surface, there are still several key differences that investors need to be aware of before choosing one for their portfolio, a number of which we have highlighted below:

WisdomTree Australia & New Zealand Debt Fund (AUNZ - ETF report)

AUNZ is the slightly older product of the two, having beaten PIMCO’s product to the punch in the Oceania bond space. The fund doesn’t track an index but rather seeks a high level of total returns made up of both income and capital appreciation. This is done by investing in debt securities that are denominated in either Australian or New Zealand dollars with a heavy focus on government bonds (read November ETF Asset Report: Bond ETFs Are Big Winners).

In fact, the portfolio of AUNZ looks to be roughly equally allocated between three sectors; government bonds, semi-government bonds, and supranational bonds. Australian government bonds dominate the list of top holdings although a few supranational issues— denominated in Aussie dollars—also find their way into the top ten as well. New Zealand bonds, however, make up about 11% of the portfolio helping to juice the overall return of the fund since these securities tend to have higher rates than their Australian cousins. Nevertheless, the 30 Day SEC Yield of AUNZ is about 3.75% with an effective duration of just under 4.2 years. This yield is far higher than similar American or European products which have a duration as low as this WisdomTree fund, suggesting that investors may get a bigger bang for their buck in this product when compared to other Western nations.

PIMCO Australia Bond Index Fund (AUD - ETF report)

For investors seeking a play focused on the broad Australia bond market, AUD could be a way to go. The fund tracks the BofA Merrill Lynch Diversified Australia Bond Index which tracks the performance of large, Australian dollar denominated investment grade debt instruments publicly issued in the Australian domestic market, including sovereign, quasi government, corporate, securitized and collateralized securities.

The current portfolio consists of 30 securities with top weightings going to a variety of Australian government institutions including local governments and bonds due from the Federal Republic of Australia. However, unlike AUNZ, this PIMCO ETF doesn’t allocate anything to New Zealand bonds and does use Aussie corporates in its basket. Bonds from companies such as Telstra and HSBC Bank make their way into the top ten holdings of AUD and, much like the New Zealand bonds in AUNZ, these securities help to juice the overall yield of the fund. Nevertheless, this leads AUD to have a yield slightly lower than its WisdomTree counterpart at 3.61% but it also helps to give the fund a lower effective duration of just 4.05 years (also read Forget FXI: Try These China ETFs Instead).

This suggests that for investors seeking the highest yield possible, AUNZ could be the best choice thanks to its slightly higher payouts. Additionally, investors may prefer AUNZ if they are looking to tap into New Zealand bonds as well, diversifying across the region. However, for investors seeking an option with lower interest rate risk and the inclusion of corporate bonds, AUD seems like the better choice. The fund does a nice job of including all types of bonds in Australia and the exclusion of the AA+ rated New Zealand in favor of the AAA Australia could serve to further limit the risk of this fund. Either way, both products look to do a nice job of offering investors exposure to the space. Just remember, while the funds may seem identical, they have several key differences that should easily help investors differentiate between the only two Australia bond ETFs on the market today.

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