Update: iShares Euro Aggregate Bond UCITS ETF

The multi-sector nature of this ETF is designed to make it work as the central – perhaps the only – fixed income element in a EUR-denominated investment portfolio. In fact, this ETF could be defined as the ultimate “one stop shop” for investors to meet their fixed income exposure needs. The trade-off is one of a lack of say in the asset allocation decision-making process, which is determined by the benchmark. 

This ETF 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.

Fundamentale Analyse

The Eurozone economic recovery seems to have found a lease of life on the back of the ECB’s ultra-loose monetary policy stance. Eurozone interest rates are zero-bound, with an explicit commitment to leave them at these levels for a very protracted period. In January 2015, the ECB announced a massive quantitative easing programme involving the purchase of 60bn Euros of government bonds on a monthly basis until, at the earliest, September 2016. Prior to the QE announcement, the ECB had also approved a new tranche of its programme of purchases of covered bonds and started a new programme of purchases of asset backed securities. The ultimate objective of this policy set-up is to address deflationary risks while boosting lending to the private sector; particularly SMEs. 

EUR-denominated fixed income assets have benefited from a decent body of demand over the past years. In terms of intra-country sovereign bond trends; the easing of tensions since H2-12 has resulted in a significant corrective move, with yields of peripheral countries strongly down from the crisis highs, though continuing to trade above those of core economies. Volatility on this front is now intimately linked to resurgent political risks. However, it could fair to say that the upside to core-peripheral spreads may have been somewhat capped by ECB activism. 

As it pertains the corporate bond market; issuance and price trends continue to be primarily shaped by the still abnormal functioning of traditional bank lending channels to the wider economy. The unclogging of banking lending channels is ultimately a function of the normalisation of economic conditions. Considering the ECB policy outlook, corporate bond issuance could remain above its long-term historical average, and yields at very low levels, for the foreseeable future. Indeed, so far, the increase in corporate bond issuance has been easily absorbed. 

Meanwhile, the covered bond market would be bound to remain somewhat supported as long as the ECB engages in outright purchases.

In principle, the ECB’s ultra-loose policy stance would provide the basis for continued support of fixed income valuations, not least given the divergent monetary policy cycles between the Eurozone and other key developed economies (e.g. USA). However, since early Q2 20015 financial markets have been pricing in higher chances of sustained success of the ECB policies (e.g. higher economic growth and a pick-up of inflation). This has already weighed on EUR-denominated bond valuations and may continue to do so.

Indexkonstruktion

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.

Fondskonstruktion

iShares uses physical replication to track the performance of the Barclays Capital Euro Aggregate Bond index. Given the large number of index constituents (e.g. over 3000), iShares uses stratified sampling to construct the fund. The index is broken down into sections, each representing key risk factors (e.g. duration, currency, country, rating, sector). The managers then choose bonds that mimic the risk profile of each section. The aggregate result is a portfolio that represents the index’s overall risk profile, while allowing the ETF manager to avoid purchasing bonds that may suffer from illiquidity. Eurozone issuers account for close to 90% of the fund’s value, with France, Germany, Italy and Spain the main contributors (e.g. 60-70%). Non-Eurozone issuers account for the remaining 10%. 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 tends to have a modified duration in the 5.0-6.0% range. This ETF is denominated in EUR and distributes dividends on a semi-annual basis, with historical data showing a January-July payment pattern. iShares engages 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% of AUM per fund. The average on loan for this ETF for the year to end March 2015 was 10.5% for an average return of 2bps. 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 62.5/38.5 between the ETF and BlackRock, respectively.

Gebühren

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. There are also rebalancing costs whenever the index changes composition.

Alternativen

According to our research, the only available alternative to this iShares ETF is the SPDR Barclays Euro Aggregate Bond ETF. Also physically replicated and tracking the same benchmark, the SPDR fund charges a comparatively lower TER of 0.20%. However, as of this writing, the iShares fund remains clear market leader, as measured in AUM terms.

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.