ETFs are “excellent” products to gain exposure to a wide variety of asset classes, according to IG’s Oliver Smith, and this includes deeply out-of-favour government bonds.
Investors have understandably been nervous on the asset class recently, given historically low yields, high prices and potential interest rate rises in some developed markets on the cards over the medium term.
Performance of index over 5yrs
Source: FE Analytics
However, the portfolio manager argued that there are a wide range of ways to gain exposure to the market area and that it is simply a case of investors doing their homework before buying.
“Investors in bonds need to take into consideration the shape of the yield curve, which is currently upward sloping, but from a very low base level,” Smith said. “Short-dated government bonds yield very little (0.1 per cent for a two-year bond), while longer-dated maturities have a higher yield, but offer significantly less income than they did in the past.”
Not only do investors need to keep an eye on maturity, the wide range of ETFs available which span across different countries and currencies can provide very different outcomes for investors. Depending on whether they are hedged or not, changes in exchange rates can also significantly impact performance.
In the below article, Smith talks through six very different ETFs and why they could be attractive for investors.
Lyxor FTSE Actuaries UK Gilts Ucits ETF
Launched in October 2016, the Luxembourg-domiciled Lyxor FTSE Actuaries UK Gilts Ucits ETF (GILS) tracks the FTSE Actuaries UK Conventional Gilts All Stocks index, which has an average maturity of 15.36 years.
“For investors wanting exposure to the entire yield curve, GILS has a total expense ratio (TER) of just 0.07 per cent and has physical exposure to the underlying securities in the index,” the portfolio manager explained. “It yields 1.6 per cent and has a duration of 10.8 years, meaning investors must be prepared for capital losses if the yield curve rises.”
While more than one-quarter of the fund is exposed to gilts with a duration in excess of 25 years, 14.16 per cent of them have a duration of three-to-five years, 12.63 per cent have a one-to-three year duration and 11.92 per cent have a duration of between 10 and 15 years.
Since launch, the ETF has a tracking error compared to its benchmark of 1.15 (a tracking error below two suggests a passive approach and a zero tracking error would indicate a fund was a perfect replication of a benchmark. This would of course be impossible due to fees and the fact funds will not be fully-invested at all times in order to maintain liquidity).
SPDR Barclays 15+ Year Gilt Ucits ETF
Smith said: “This ETF targets the long end of the yield curve, and has the highest yield to maturity of the six ETFs at 1.67 per cent.
“The average maturity of the underlying bonds is 28.7 years, but more importantly, the effective duration is 19.55 years – making it very sensitive to changes in interest rates so larger capital losses, or gains, are likely if interest rate volatility rises.”
SPDR Barclays 15+ Year Gilt Ucits ETF has an FE passive rating of four crowns and a TER of 0.15 per cent.
Since its launch in 2012, the fund has a tracking error ratio of 0.55 as well as a maximum drawdown – which measures the most money lost if bought and sold at the worst times – of 13.25 per cent.
Its Bloomberg Barclays UK Gilt 15+ Year Index has, over five years, returned 38.01 per cent. While 84.94 per cent of the fund’s holdings have a maturity in excess of 20 years, 14.93 per cent have a 10-15 years maturity and the remaining 0.13 per cent is held in cash.
iShares Global Government Bond Ucits ETF
Launched in 2009, iShares Global Government Bond Ucits ETF (IGLO) has a dollar currency base and is $920.3m in size.
“This ETF gives exposure to G7 bonds, including Canada, France, Germany, Italy, Japan and the US,” Smith explained. “It is not currency-hedged, meaning that should sterling gain in aggregate against those countries’ currencies, investors will likely make losses. It has a yield to maturity of 1 per cent, and a TER of 0.2 per cent.”
Over five years, the fund has returned 14.55 per cent and has done so with a tracking error of 0.4 relative to its Citigroup G7 index. It also has a maximum drawdown of 11.59 per cent of this time frame.
Performance of fund vs benchmark over 5yrs
Source: FE Analytics
The fund has a highly-diversified exposure to government bonds, with its top 10 holdings accounting for just 4.48 per cent of the overall portfolio. Its regional weightings are the US at 41.2 per cent, followed by Japan at 24.4 per cent, France at 9.49 per cent and Italy at 9.12 per cent. It also has smaller weightings to Germany, the UK and Canada.
Its average duration is 7.77 years and its weighted average maturity is 9.6 years.
db x-trackers II Global Government Bond Ucits ETF
Smith said: “Investors seeking GBP-hedged exposure to global bonds could consider this ETF from the db x-trackers range.
“It has a broader remit than IGLO with exposure to 19 countries through the Citi World Government Bond Index. The TER is 0.25 per cent and it has a yield to maturity of 0.96 per cent.”
The db x-trackers II Global Government Bond Ucits ETF only launched in April 2017 and aims to track the Citi World Government Bond Index – Developed Markets index, currency hedged in US dollar terms.
Unfortunately, as FE Trustnet does not hold data for the index (not to mention it would be a very short time horizon), we are unable to provide its tracking error.
The Luxembourg-domiciled fund is denominated in US dollars and through its chosen benchmark aims to reflect the performance of a range of fixed rate, local currency, investment grade sovereign debt issued in developed markets.
Its largest regional weightings are the US at 36.27 per cent, Japan at 21.65 per cent and France at 7.94 per cent.
Lyxor iBoxx $ Treasuries 1-3yr Ucits ETF
“For many people, US dollars are the ultimate refuge in times of crisis,” Smith continued. “A sterling investor can buy the GBP share class of this ETF to get exposure to the US dollar, which eliminates the need to pay broker FX fees.
“Lyxor has made a real push to lower its fixed income fees, and this ETF has a TER of just 0.07 per cent.”
Lyxor iBoxx $ Treasuries 1-3yr Ucits ETF was launched in October 2016 and, by tracking the Markit iBoxx USD Treasuries 1-3yr index, aims to offset the impact of monthly variations of the index local currency versus whichever currency-hedged share class they choose.
Its benchmark provides exposure to US Treasuries with a maturity between one and three years; the fund currently has an average maturity of 1.87 years, a coupon rate of 1.77 per cent and an average duration of 1.84 years.
Unfortunately, we have no data on the index so we are unable to determine its tracking error. In sterling terms, the fund is down 7.29 per cent since launch. Lyxor iBoxx $ Treasuries 1-3yr Ucits ETF yields 1.41 per cent.