Australian investors have historically not been big fans of bonds. That can be explained by the lack of a retail bond market in this country – until relatively recently – and a much stronger philosophical attraction to shares and property on the part of Australians. Asset allocation specialists often bemoan the almost total lack of fixed-income in Australian retail portfolios, versus figures as high as 20% in offshore markets; and in the case of retirement funding, Australia has a back-to-front approach to asset allocation, with shares the dominant holding, compared to fixed-income in many northern hemisphere markets.

In the absence of retail avenues for exposure to the bond markets, Australian investors have looked for their income to the term deposit market, and to share dividends. But as the official Reserve Bank cash rate sank from 7.25% in 2008 to its record low of 1.5% – where it has now been for a year – average five-year term deposit rates have plummeted from 7.5%–8% (which investors were receiving as recently as 2010) to a current average, according to Canstar, of 2.79%. The average one-year term deposit rate is not even 2.5%.

The largesse of the dividend imputation system has also led Australian investors to rely heavily on income from shares, especially in self-managed superannuation funds (SMSFs), where a fund operating in accumulation phase, with a tax rate of 15% on earnings, receives a partial rebate of the franking credits attached to a fully franked dividend, because it does not need all of the franking credits to offset tax on the dividend.

An SMSF in pension phase (paying pensions to all members), with no tax on its earnings, receives a full rebate of the franking credits, because it has no tax to offset. For SMSFs, a dollar of fully franked income is effectively worth much more than a dollar.

SMSFs look to stocks such as Telstra and the big four banks for gross yields in the range of 7.6%–8.9%. Even the market average gross dividend yield stands at just under 5.2%.

That sort of figure tends to overwhelm a more textbook approach to asset allocation – as do the low yields on term deposits and bonds.

But recent product development in the exchange-traded fund (ETF) market has been notable for what it offers retail and SMSF investors in terms of fixed-income, giving them all of the asset allocation attributes of the asset class, with the liquidity of a stock exchange listing. It is often said that ETF product development now allows retail investors to implement virtually their entire asset allocation by using ETFs – that is very much the case with ETFs. At the moment, though, an income-oriented investor would almost need to be an asset allocation purist to do this – because the share market seems to be delivering on all fronts.

In asset allocation theory, fixed-income is a defensive allocation, that gives strong diversification against riskier holdings –  because it tends not to be correlated to the share market – while being a stable source of income. The last time Australian shares made a loss in a calendar year – a 9.7% fall in 2011 – holding Australian bonds would have lessened the pain: that asset class rose by 11.4%.

In the last couple of years, ETFs have started to offer Australian investors diversification across the entire fixed-income spectrum, from cash to corporate bonds, offering them the chance to earn enhanced returns for some of the areas they must hold – such as cash – and exposure to different sectors, to allow a more tailored, diversified portfolio.

For example, cash ETFs have emerged, including BetaShares’ Australian High Interest Cash ETF (ASX code: AAA), the UBS IQ Cash ETF (MONY), iShares Core Cash ETF (BILL) and iShares Enhanced Cash ETF (ISEC). In these ETFs investors are avoiding the hassle of setting up cash accounts at a bank, but paying a (small) management fee and brokerage when buying the ETF through their existing stockbroking account. And the longest-running of these funds, the BetaShares’ Australian High Interest Cash ETF, has shown a solid ability to outperform cash: since inception (March 2012) has paid 25% more than the 30-day bank bill swap rate, at 3.1% a year versus 2.47% a year.

ETFs offering exposure to a wide range of government, semi-government and corporate bonds have come to the market, including the iShares Core Composite Bond ETF (IAF), the Vanguard International Fixed Interest Fund (Hedged) (VIF), the iShares Core Global Corporate Bond ETF (A$ hedged) (IHCB), the iShares JP Morgan US$ Emerging Markets Bond (A$ hedged) (IHEB), the iShares Global High Yield Bond (A$ hedged) (IHHY) and the Vanguard International Credit Securities Index Fund (Hedged) (VCF).

More recently, ETF issuers have sliced the Australian market into even more targeted exposures, such as the Van Eck Australian Corporate Bond Plus ETF (PLUS), the BetaShares Australian Bank Senior Floating-Rate Bond ETF (QPON) and the VanEck Vectors Australian Floating-Rate ETF (FLOT). In particular, FLOT and QPON are the first floating-rate bond ETFs, meaning the coupon or interest rate paid is tied to the current RBA cash rate. These will not earn as much return as the corporate bond ETFs on the ASX, but are lower-risk and should be less volatile.

This string of ASX listed fixed income ETFs allows local investors to choose quite distinct exposures, and is welcome for that reason.

The most recent – in fact yet to launch – development is even more intriguing, and arguably completes the set of income-bearing exposures.

Australian investors have long had a love affair with hybrid notes – mainly because of the faith they place in the big four banks – viewing them as an alternative to bonds. Hybrids are theoretically a mixture of debt and equity, but the equity side usually dominates. They are not true fixed income at all, and can be a lot riskier than retail investors seem to think.

The first ETF to cover hybrids, the BetaShares Active Australian Hybrids Fund, is about to launch: it will give hybrid investors an alternative to direct investment in ASX-listed hybrids, offering in one stock a diversified exposure to the hybrid sector. The new ETF will be actively managed by Coolabah Capital Investments, and will comprise hybrid securities, bonds and cash or any combination of these assets. The ETF will be actively managed, so the management fee will be a bit higher than other income-oriented ETFs, at 0.45% a year (there will also be a performance fee equal to 15% of any return achieved over an as-yet unspecified benchmark.)

Retail investors and SMSFs can now put together a targeted and diversified exposure to any area of the income-bearing spectrum they choose. Many will say, ‘why would you bother, when we must be near the end of a 30-year bond bull market?’ The answer to that lies in the defensive asset allocation attributes of fixed interest, which could come in very handy down the track, offering reasonable returns with less risk than relying totally – and that’s the main point – on share dividend income.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.