Bypass bank risk with ETFs

With governments are under enormous pressure to guarantee savers' deposits, short-term bonds have gained in appeal. Paul Amery tips the best exchange-traded funds to profit.

As Douglas Carswell MP said last week, "the modern banking system means there are more people who think they are owed money than there is money in the banks". When you deposit money in a bank, you are lending money to the bank. But banks in turn write loans that are many multiples of their deposit bases.

If every depositor wants their money back at once, you can get a run on the bank. The reason we're not a lot more sensitive to the risks banks take with our cash is that we've been conditioned by a long period of relative stability to expect that our money will be returned when we want it.

Government-provided deposit insurance also provides a psychological prop for savers and the banks. In Britain the Financial Services Compensation Scheme (FSCS) insures deposits up to a limit of £85,000 per person, per institution. But the FSCS relies on an inherently unstable pay-as-you-go funding model, like most public sector pensions.

No one is suggesting it can't meet its promises. But as we've seen in the eurozone crisis, some government debts can be made subordinate to others; or, as in the case of Cyprus, insured depositors may have to wait to get their money back.

If you have savings but are concerned about bank risk, what are the alternatives? The iShares FTSE Gilts UK 0-5 (LSE: IGLS), iShares Barclays $ Treasury Bond 1-3 (LSE: IBTS) and iShares Barclays Euro Treasury Bond 0-1 (LSE: IEGE) ETFs invest in short-maturity government bonds from the UK, US and the eurozone, respectively.

All carry an element of interest-rate risk if rates rise, you will suffer some capital losses but these ETFs offer an easy way of investing in a selection of government bonds that are close to maturity. Government debt is not risk-free, of course, so check whose countries' bonds you're investing in.

ETF issuer Source offers alternatives via ETFs run by giant US bond manager PIMCO. PIMCO's Sterling (LSE: QUID), US Dollar (LSE: MINT) and Euro Short Maturity (LSE: PJS1) Source ETFs are actively managed and aim to maximise current income, while preserving capital and offering a high degree of liquidity, according to the issuer.

iShares' ETFs charge 0.2% a year, Source's 0.35%. With yields on short bonds at rock bottom, you won't get much, if anything, in income by investing in these ETFs. But they all offer a way of keeping cash in deposit-like form without direct exposure to banks.

Paul Amery edits www.indexuniverse.eu, the top source of news and analyses on Europe's ETF and index-fund market.

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