Which is the better option: government retail bonds or an exchange-traded fund?

If you're looking to buy inflation linked bonds, there are two main options for the individual, both of them investor-friendly. You could either invest in RMB's Bips Inflation-X exchange-traded fund (ETF) or Treasury's Retail Savings Bond initiative.

Inflation-linked bonds are not the most exciting of investments. But they probably provide the most certain way of ensuring your investment returns exceed inflation. Your investment will grow at the same pace as the official CPI inflation index, as measured by Stats SA, and on top of this you will earn a small return of 2-3% a year.

The bonds might appeal to conservative investors who are reluctant to commit to a stock market that is not nearly as cheap as it was, having risen more than 50% since March. 

The retail bonds offered by government are an attractive proposal. You can invest as little as R1 000 or as much as R5m. There are no fees or commissions. Investors can choose from inflation-linked bonds with lifespans of three, five or ten years. But perhaps best of all, the bonds are not subject to the dreaded Fica. Compared with most other investments, putting money into a retail bond is almost disconcertingly easy; you do not need to provide copies of ID book, bank statement, proof of residence, etc.

Retail inflation-linked bonds with a three-year lifespan pay 2.25%, five-year bonds pay 2.5% and ten-year bonds pay 2.75%. Interest is paid twice a year. The bonds can be bought online or via the Post Office or Pick n Pay. The bonds must be held for their lifespan, otherwise a penalty is payable.

RMB's Bips ETF tracks the performance of four government-issued inflation-linked bonds. The lifespan of these bonds varies from four to 19 years. A recent newsletter puts the yield of the ETF at 2.65% per year, which is in line with what the retail bonds offer. However, the disadvantage of Bips is that it is not funded by the taxpayer and there are thus manager fees to pay. This comes at a cost of "up to" 0.39% per year.

Unfortunately the costs don't stop there. There are also the costs of buying, holding and selling the ETF. You can do this in one of the following two ways:

• Through an ordinary stockbroker. This will cost at least R100 to either buy or sell shares in the ETF. The holding cost is typically R40 a month. For more information on stockbroker fees, see this article.
• Through an investment plan. Former Satrix boss Mike Brown has started a website, www.etfsa.co.za, which acts as a one-stop shop for South Africa's exchange-traded funds. Through this platform, it is possible to invest in ETF via monthly debit orders of R300 or more or lump sum payments of R1 000 or more. Buying or selling the Bips Inflation-X ETF costs 0.1% of the value of the trade. There is also a debit order fee of R3.50. Holding costs come to 1% a year. Fees quoted exclude VAT.

It's clear that the retail treasury bonds have a strong cost advantage over the Bips ETF. But one of the advantages of the ETF is that it can be traded at will, incurring no penalties other than the brokerage costs. In contrast, early redemption of a retail bond will cost you up to six months' interest. Thus, if you with to withdraw R10 000 early on an inflation-linked bond paying 3% a year, it could cost you up to R150.  Early withdrawal in the first year of investment is only permitted under "extraordinary circumstances".

Write to Julius Cobbett: julius@moneyweb.co.za

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