The iShares Barclays Capital Euro Aggregate Bond ETF offers investors exposure to the aggregate performance of the main sectors of the EUR-denominated fixed income market, namely government and quasi-government, corporate and covered bonds. In most cases fixed income holdings provide a steady and fairly reliable revenue stream via coupon and redemption payments. Those attracted by this latter property should be advised that this iShares fund distributes dividends on a semi-annual basis.
The multi-sector nature of this ETF is designed to make it work as the central – perhaps the only – fixed income element in a core investment portfolio. In fact, this ETF could be defined as the ultimate “one stop shop” for investors to meet their fixed income exposure needs in their broadest sense. The obvious trade-off is one of a lack of say in the asset allocation decision making process as investors in this ETF ultimately delegate the task of deciding the level of exposure to the various fixed income segments to both the index and ETF providers.
This is an ETF that covers the whole maturity spectrum of the EUR-denominated fixed income universe, and so it could help investors to shield the overall investment portfolio against negative performance effects arising from market shifts across the yield curve, whether near-term tactical or long-term strategic in nature. These yield curve movements will be fundamentally driven by a combination of the broad international and the local macroeconomic environments of the different issuing countries and fixed income sectors this ETF covers.
Fixed income holdings should be part of an optimal mix of asset classes in an investment portfolio at any given time. However, it is fair to say that investor interest in fixed income investments has been on the rise since the onset of the global financial and economic crisis. In general terms, bonds provide a steady income stream and tend to have low or negative correlation with equities, thus helping investors manage overall exposure to risk.
Perceptions about the economy have improved into 2013, mainly as a result of the easing of tensions in the Eurozone sovereign debt market in H2-12 after the verbal intervention of the ECB President Mario Draghi in defence of the Euro. As a result, there is talk of a widespread reallocation of money flows into riskier asset classes (e.g. equities) and away from fixed income. However, the fact remains that risks to the overall outlook are still skewed to the downside. As such, despite an upside to yields, these still remain at low levels by historical standards, no doubt aided by very accommodative monetary policy settings in developed economies.
The easing of Eurozone tensions has resulted in corrective yield action in the sovereign market, with yields of peripheral countries significantly down from the highs and those of safe-haven issuers such as Germany, France and the Netherlands, up from the historical lows. However, this correction, though welcome, does not solve the dichotomy in economic performance between core and periphery, with the latter still struggling considerably. As such, Eurozone periphery government bonds will continue yielding above those of core economies for the foreseeable future. However, investors in this ETF will have to carefully weigh up whether potential capital losses on core government bonds are adequately offset by gains on the peripheral exposure of the underlying index.
Meanwhile, on the corporate bond market side of things, issuance and price trends continue to be primarily shaped by the abnormal functioning of traditional bank lending channels to the wider economy. Some signs of improvement have been noted into 2013, with Eurozone banks becoming less reliant on ECB liquidity funding. However, we are still a long way away from a resumption of normal bank lending conditions, and so corporate bond issuance might remain above its long-terms historical average for some years to come. The full unclogging of banking lending channels is ultimately a function of the normalisation of economic conditions and the adequate recapitalisation of European banks. Only under these conditions, corporate bond issuance is likely to diminish. However, this still looks a medium-to-long-term prospect. So far, the increase in corporate bond issuance has been absorbed by a market wary of taking on sovereign risk. However, the risk going forward is that a sustained move towards equities might dent corporate bond valuations.
The Barclays Capital Euro Aggregate Bond index tracks the combined performance of the EUR-denominated fixed rate bonds with an investment grade rating issued both in the Eurozone and Eurobond domestic markets irrespective of issuer. The broad distribution of this multi-sector fixed income index is as follows: 55-60% government bonds, 15-20% corporate, 10-15% covered and 10-15% quasi-government. Eligible bonds must have a minimum outstanding of EUR 300mn and a minimum remaining maturity of one year.
The index is calculated on a total return basis using bid prices – except for government bonds which use mid prices – provided daily by Barclays Capital traders, third-party vendors or for traditional Pfandbriefe using an interpolated yield curve. Offer prices are used for new issues entering the index. Prices are sourced exclusively from the London market at 16:15. If the UK market is closed, pricing remains unchanged until the close of the next UK business day. The index is rebalanced on a monthly basis on the last day of each month. Any income generated during the month is held in the index without a reinvestment return until rebalancing when it is removed from the index.
iShares uses physical replication to track the performance of the Barclays Capital Euro Aggregate Bond index. This ETF was launched in March 2009 and is domiciled in Ireland. It is denominated in EUR and distributes dividends on a semi-annual basis, with historical data showing a January-July payment pattern.
As the benchmark index of reference has a large number of constituents (e.g. over 3000) iShares uses statistical sampling to construct the fund. As of this writing (e.g. end January 2013), the number of fund constituents stood around 1575. Despite the difference in the number of constituents, the fund tends to mirror the index’s statistical distribution of the various fixed income segments (e.g. government, quasi-government, corporate and covered). As per geographical origin, Eurozone issuers account for close to 90% of the fund’s basket value, with France and Germany as the main contributors (e.g. 40% of the fund’s value). Non-Eurozone issuers account for the remaining 10% of the basket. In terms of maturity segmentation, the fund is biased to the short and medium-dated brackets (e.g. around 65% of the basket value). As a result this ETF has a modified duration around in a 5.0-5.5% range.
iShares may engage in securities lending in order to optimise the ETF’s tracking performance. BlackRock acts as investment manager on behalf of iShares. The amount of securities that can be lent is capped to 50% per fund. Lending operations are hedged by taking UCITS-approved collateral greater than the loan value and by revaluing loans and collateral on a daily basis. The collateral is held in a ringfenced account by a third party custodian. The degree of overcollateralisation is a function of the assets provided as collateral, but typically ranges from 102.5% to 112%. Lending revenue is split 60/40 between the ETF and BlackRock, respectively.
The total annual expense ratio (TER) is 0.25%. Additional costs potentially borne by investors and not included in the TER include bid/offer spreads and brokerage fees when buy/sell orders are placed for ETF shares.
The iShares Barclays Capital Euro Aggregate Bond ETF was the sole multi-sector bond ETF in the European market until May 2011 when State Street launched an ETF under its SPDR brand tracking the same Barclays Capital index. As of this writing, this remains the only like-for-like alternative to the iShares ETF. Also using physical replication, the SPDR ETF is competing to gain market share from iShares primarily on cost. It is marketed with a TER of 0.20%. At this stage, the iShares fund remains clear market leader, as measured in terms of assets under management.
Investors wanting to consider other European ETF providers have no choice but to select individual building blocks (e.g. government, corporate, covered) in order to achieve the aggregate fixed income market exposure of their choice.