Korean retail investors flock to ultra-short bonds on rising interest rates

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Bond investment in South Korea is seeing a paradigm shift on the recent spike in U.S. long-term bond yields. While Korean investors had been buying long-term bonds in droves to capitalize on lower interest rates, they are now turning eyes to ultra-short bonds with maturities of less than three months to go after steady interest income.

According to ETF.com, a U.S. data tracker for exchange traded funds (ETFs), on Wednesday, the U.S. ETF market have seen significant inflows into ultra-short bond ETF products in the last month. The iShares 0-3 Month Treasury Bond ETF (SGOV), which invests in bonds with maturities under three months, attracted funds worth $1.7billion over the past month.

SPDR Bloomberg 1-3 Month T-Bill ETF (BIL), which invests in short-term bonds with maturities of one to three months, also drew investment worth $1.1 billion, while the Goldman Sachs Treasury Access 0-1 Year ETF (GBIL) and U.S. Treasury 3 Month Bill ETF (TBIL) saw inflows of $427.43 million and $319.12 million, respectively.

On the other hand, the iShares 20+ Year Treasury Bond ETF (TLT), a leading long-term bond product, attracted a mere $336.55 million in funds during the same period.

Local retail investors are also increasing their share of ultra short-term bonds.

According to the Korea Securities Depository, retail investors net purchased $13.87 million of SGOV ETFs in the last one month, double the amount of net purchases in the previous month.

In general, the market turns to long-term bonds when interest rates are expected to fall.

Long-term bonds tend to be more volatile depending on changes in interest rates as they can offer larger gains than shorter-dated bonds when rates fall. Conversely, when market interest rates rise, short-term bonds become more attractive than long-term ones given their less sensitivity to interest rates. They offer interest income at a higher rate than long-term bonds.

Demand grows strong for short-term bonds and money market funds (MMFs) when market interest rates rise or stocks experience a correction in hopes to later buy stocks and long-term bonds at a lower price.

“Funds flock to MMFs and short-term bonds as the expected return on stocks is not high at the moment following a rise in stock prices in the first half of the year,” said a chief executive officer of an asset management firm. “Many investors are attracted to the idea of earning a steady 5 percent return.”

In particular, upward pressure on short-term interest rates is not greater than that of long-term bonds in the U.S. Additionally, the U.S. Treasury’s issuance of government bonds mostly consists of mid to long-term bonds, which means no risk of increasing supply. U.S. inflation has also been trending lower, albeit slowly. In fact, while the U.S. 10-year Treasury rate recently surged to 4.3 percent, the U.S. 3-month Treasury rate has rather fallen from its peak in April this year.

“We believe there are bond investment opportunities centered on short-term bonds in the fourth quarter,” said Ha Jae-seok, an analyst at NH Investment & Securities Co. “If there’s not much upward or downward potential for long-term interest rates, it is a good time to invest in long-term bonds for covered calls.”

Demand for interest rate products is also high in the domestic ETF market.

According to market data platform ETF CHECK, the KODEX CD Interest Rate Active ETF (Synthetic) and Tiger SYNTH-KOFR ACTIVE ETF had the largest inflow of funds in the ETF market over the past month, with 743.2 billion won ($556.7 million) and 577.3 billion won, respectively. Interest rate ETFs are also known as high-yield savings products. They are also highly liquid as investors can have their money returned on demand.