Analyse: CS ETF (CH) on Swiss Bond Index Domestic Government 3-7

Despite the medium-dated maturity bias, investors may also consider this ETF for cash (e.g. CHF) equitisation purposes. However, attention should be given to the potential for capital losses arising from exposure to domestic interest rate risk. Regarding this latter point, those with a Swiss-centric portfolio can also use this ETF for duration management purposes in response to variations in interest rates, with the medium-dated maturity of the fund allowing for both lengthening and shortening strategies depending on the overall duration of the investment portfolio.

Unless used as the fixed income building bloc of a Swiss-centric investment portfolio, the majority of likely uses for this ETF would make it more a satellite than a core element in asset allocation. As this is a CHF-denominated non-UCITS-compliant ETF, non-Swiss investors will have to account for foreign exchange and specific tax implications whenever making use of it.

Fundamentale Analyse

Switzerland is an international safe-haven of choice at times of crisis. This is predicated on a raft of factors, amongst which macroeconomic strength and sound fiscal and budgetary policy management. The federal government is constitutionally bound to keep a balanced budget over the economic cycle, and although it is allowed to run deficits at times of economic slowdown, the fact is that budget shortfall projections rarely exceed the 1.0% of GDP per annum. Swiss federal government bond issuance is not a common market event, while the commitment to budgetary stability has translated into a substantial reduction in the overall public debt burden from an average of 50-55% of GDP in the 1996-2005 period to 35-40% of GDP thereafter. Even factoring in increases to account for the budget-deficit-generating phase of the economic cycle, the overall public debt burden should remain at comparatively low levels, particularly when put against the Eurozone.

The sovereign debt crisis in the Eurozone has prompted relentless safe-haven flows into Swiss government bonds over the past few years, with short-dated yields occasionally dipping into negative terrain at times of particularly heightened financial market tension. The easing of Eurozone debt tensions in H2-12 has pushed yields up from the historical lows, but not by a substantial measure.

These safe-haven flows pushed the Swiss Franc (CHF) to levels the Swiss National Bank (SNB) saw as threatening Swiss export competitiveness and, more worryingly, with the potential to cause a sustained deflationary phase. As a result, in August 2011 the SNB lowered its three-month Libor target to 0.0% from 0.25% and in September 2011 announced it would intervene as forcefully as required in international FX markets to enforce a minimum CHF/EUR 1.20 exchange rate. This unequivocal commitment to defend this minimum exchange rate remains firmly in place as we write (e.g. end January 2013). In fact, the SNB considers that even at 1.20, the CHF is “still high” and would ideally want to see it weaken even further. Imported price pressures have been more than offset to propel the Swiss economy into a deflationary phase in 2012, with the SNB forecasting very low inflation rates ahead (e.g. -0.1% y/y for 2013 and 0.4% y/y in 2014).

The slowdown in the pace of global recovery in 2012 and the relative strength of the CHF have weighed on Swiss export potential and domestic corporate investment. GDP growth in 2012 was around 1.0% y/y, while the official forecast for 2013 is 1.0-1.5%. Risks to the growth outlook going forward remain to the downside, with any resurfacing of Eurozone debt tensions as a key risk factor.

Barring an unlikely sea-change in circumstances, Swiss monetary policy settings are likely to be kept on ultra-loose mode for a very protracted period. As a result, yields on Swiss short-to-medium-dated government bonds should be expected to remain at very low levels for the foreseeable future.

Indexkonstruktion

The Swiss Bond Index Domestic Government 3-7 is a sub-index of the Swiss Bond Index Domestic Government. The index is calculated using bid prices from SIX Swiss Exchange and is published in real time as early as 08:30 am CET. It includes all CHF-denominated fixed-rate Swiss government bonds with remaining maturity between three and seven years and minimum outstanding of CHF 100mn. Each bond is weighted by its market capitalisation. The index is calculated both on a price and total return basis, with coupon payments reinvested overnight in the latter case. Changes to the index are made on a monthly basis on the first trading day of each month.

Fondskonstruktion

The ETF was launched in November 2003 and is domiciled in Switzerland. The ETF is listed in the SIX Swiss Exchange. It is worth noting that this ETF is not compliant with UCITS legislation, meaning it cannot be passported for registration and commercial distribution to retail investors across the European Economic Area (EEA). As of this writing, the fund is authorised for commercial distribution in Switzerland and Liechtenstein. Credit Suisse uses physical replication to track the performance of the Swiss Bond Index Domestic Government 3-7 (note – total return). The reduced universe of Swiss federal government bonds allows Credit Suisse to fully replicate the underlying index, with the statistical weight of each bond in the fund’s basket reflecting their outstanding as a proportion within the 3-7y maturity bucket of the Swiss federal government bond market. As we write (e.g. end January 2013), the fund’s basket was made up of five bonds with weightings ranging from 10% to 25%. The ETF typically distributes dividends on a semi-annual basis, with most recent historical data showing a Jan-Jul payment pattern. The fund management company may invest up to 5% of the fund’s assets in futures of the underlying benchmark index. This fund may also engage in securities lending in order to optimise tracking performance. Lending operations are fully collateralised (e.g. 100%), though in most cases CS will take collateral in excess of the amount lent out. The degree of overcollateralisation is a function of the assets provided as collateral. In general terms it must be equal to at least 105%, but a lower rate of 102% can be applied if the collateral consists of liquid assets or top-rated securities. Revenues generated by securities lending is calculated daily, while income from counterparties is collected monthly. Income is allocated to Credit Suisse and the fund according to the fee-sharing arrangement in place at the time.

Gebühren

The annual total expense ratio (TER) for this ETF is 0.19%. 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.

Alternativen

Since its launch and up to late 2010, the Credit Suisse range of Swiss government bond ETFs had a free run in the marketplace. And within it, the ETF offering exposure to the 3-7y segment of the maturity spectrum was the one capturing the bulk of market interest, with its AUM well ahead of the aggregate for ETFs providing exposure to the 1-3 and 7-15 segments of the Swiss government curve.

This unopposed market run came to an end in November 2010 when UBS-IS launched a like-for-like set of Swiss government bond ETFs to rival those offered by Credit Suisse. Also using physical replication and targeting the same maturity segments as CS, the UBS-IS range of Swiss government bond ETFs charge a lower TER (e.g. 0.15% for unit class I and 0.18% for unit class A). As we write, AUM for the combined range of UBS-IS Swiss government bond ETFs lags Credit Suisse by a considerable margin.