In this report, we analyse the data around a selected opportunity set of bond indices as represented by London-listed ETFs. The report covers global, USD, EUR, GBP and Emerging Market bond markets, for aggregate, government, corporate, high yield and emerging market exposures. Whilst the bond market dwarfs the equity market, the majority of ETFs are focused on equity exposures. That is gradually changing with growing acceptance of bond ETFs as a convenient and liquid way of accessing targeted bond exposures by geography, issuer type, credit quality, or maturity profile. In this report, we:
For more information and important notices, view the full report. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Business relationship disclosure: This article references research by Elston Consulting that is sponsored by State Street Global Advisors Limited. I wrote this article myself, and it expresses my own opinions. Additional disclosure: This article has been written for a UK audience. Tickers are shown for corresponding and/or similar ETFs and may be prefixed by the relevant exchange code, e.g. “LON:” (London Stock Exchange) for UK readers. For research purposes/market commentary only, does not constitute an investment recommendation or advice, and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product. This blog reflects the views of the author and does not necessarily reflect the views of Elston Consulting, its clients or affiliates. For information and disclaimers, please see www.ElstonETF.com All product names, logos, and brands are property of their respective owners. All company, product and service names used in this website are for identification purposes only. Use of these names, logos, and brands does not imply endorsement. Image credit: Elston; Chart credit: n.a.; Table credit: n.a.
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What’s new? A bond ETF is not brand new: the first bond ETF launched back in 2002. But they are gaining traction, and as adoption increases the breadth and depth of bond ETFs have also broadened. In my first DIY multi-asset ETF portfolio back in 2008, the main bond ETFs available back then were for broad exposures like Gilts, Index-Linked Gilts and Corporate Bonds. Fast forward over ten years and there’s the ability to access much more targeted exposures. Investors can access both corporate and government bonds for GBP issuers as well as for major currency issuers such as USD and EUR, both unhedged and hedged to GBP. Furthermore, within these opportunity sets investors can select from a range of investment term options, whether short-term (e.g. <5 years), medium term (e.g. 5-10 years), or long-term (>10 years). As well as high yield bonds, more specialised bond exposures are also increasingly available. So whatever the exposure, there is an investable index to express it, and increasingly an ETF to track it. But what is a bond ETF and what are the benefits? A bond ETF is simply a bond fund that can be bought or sold on an exchange, like a share. This has three benefits: it enables access, provides diversification and creates liquidity. According to a recent survey of UK managers, while the access and diversification points are readily understood, there are concerns about liquidity.
Understanding bond ETF liquidity Ultimately the liquidity of a bond fund, whether a traditional fund or an ETF is only as good as the underlying asset. We can term this “internal liquidity”. But if liquidity of a fund itself is a concern then you are probably better off in a bond ETF than a traditional bond funds. Why is that? Simply put the stock exchange creates a secondary market for ETFs (buyers and sellers of bond ETFs trading with each other without necessarily requiring a creation or redemption of units of the bond ETF that would impact underlying bond liquidity). We can term this “external liquidity”. If liquidity of the underlying asset class was a concern and you wished to exit a traditional bond fund, your redemption would be at the discretion of the fund provider and in extremis, you may find yourself gated. So if bond liquidity is a concern, avoid traditional funds and stick to ETFs: there’s a secondary market for them other than the fund issuer. Additional liquidity of bond ETFs By way of example, 2017 provided a stress test for the bond market – in particular high yield bonds. The findings are reassuring. When high yield bond yields spiked in March 2017 and high yield bond values came under pressure, we can see how high yield bond ETFs actually fared in these challenging conditions. The volumes of the secondary market trading between investors buying/selling on exchange (which requires no trading of the fund’s underlying securities) eclipsed net share redemptions (which does require trading of the underlying securities) by a significant factor. The volumes on secondary markets increased to an average of $12.7bn in the first two weeks of March (versus a previous nine-week average of $6.7bn), whilst the net redemptions of high yield bond ETFs was only $3.5bn (representing 6.1% of total assets). A similar resilience was exhibited in November 2017. So far from triggering a liquidity stampede in the underlying holdings, the presence of secondary market enabled investors to trade the ETF holding those bonds amongst themselves. This is why secondary market liquidity is seen as an advantage, rather than a disadvantage. Secondary Market Trading of High-Yield Bond ETFs Increased When Yields Rose in 2017, 29-Dec-16 to 29-Dec-17*  Source: ICI 2018 Factbook. Figure 4.6
The ratio of secondary market volume to net share issuance is therefore one measure of bond ETF liquidity, but the most indicative measure of bond ETF liquidity is bid-ask spread. Conclusion Innovation for bond ETF investing is focused on more nuanced index design and construction of bond ETFs which provide the tools managers need to reflect their views as regards issuer type, term and credit quality when allocating to bonds. The adoption of bond ETFs is demand-led as it enables access, provides diversification and creates liquidity. This is and should be welcome to investors large and small. For more information and important notices, view the full report. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Business relationship disclosure: The article includes references to research by Elston Consulting that was sponsored by State Street Global Advisors Limited. I wrote this article myself, and it expresses my own opinions. Additional disclosure: This article has been written for a UK audience. Tickers are shown for corresponding and/or similar ETFs and may be prefixed by the relevant exchange code, e.g. “LON:” (London Stock Exchange) for UK readers. For research purposes/market commentary only, does not constitute an investment recommendation or advice, and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product. This blog reflects the views of the author and does not necessarily reflect the views of Elston Consulting, its clients or affiliates. For information and disclaimers, please see www.ElstonETF.com All product names, logos, and brands are property of their respective owners. All company, product and service names used in this website are for identification purposes only. Use of these names, logos, and brands does not imply endorsement. Image credit: n.a.; Chart credit: ICI; Table credit: n.a. 
We conducted a Survey of senior portfolio managers and decision makers from firms whose combined assets under management is in excess of £500bn. The survey was designed to get a better understanding on how those managers approach bond investing. Our key findings based on the survey are summarised below:
For more information and important notices, view the full report. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Additional disclosure: The data in this article comes from an Elston ETF Research report “Bond ETF Investing Survey” that was sponsored by State Street Global Advisors Limited. We warrant that the information in this article is presented objectively. For further information, please refer to important Notices and Disclosures in that Report which is available on our website www.ElstonETF.com This article has been written for a UK audience. Tickers are shown for corresponding and/or similar ETFs prefixed by the relevant exchange code, e.g. “LON:” (London Stock Exchange) for UK readers. For research purposes/market commentary only, does not constitute an investment recommendation or advice, and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product. This article reflects the views of the author and does not necessarily reflect the views of Elston Consulting, its clients or affiliates. For information and disclaimers, please see www.ElstonETF.com Image credit: Elston Consulting; Chart credit: Elston Consulting; Table credit: Elston Consulting BMO has lowered the cost of its bond ETF range by -43% from 30bp to 17bp as it passes through the economies of scale to end investors.
BMO’s bond ETFs offer access to the global corporate bond market, whilst giving investors the choice to select their preferred exposure, as defined by maturity. iShares offers the most popular London-listed global corporate bond ETF (CRPS). This tracks the Bloomberg Barclays Global Aggregate Corporate Bond Index at 0.20% TER. Its GBP-hedged version (CRHG) understandably costs slightly more at 0.25% TER for the convenience of in-built currency hedging. Like iShares, BMO also offers a GBP-hedged range, but has a more nuanced approach by offering investors a choice of three different ETFs each with a different maturity range: 1 to 3 years (ZC1G), 3 to 7 years (ZC3G) and 7 to 10 years (ZC7G). This compares to the average maturity of the main index of approximately 9 years. The ability to access this exposure by maturity is particularly useful for UK institutional and pension scheme investors who are looking to construct liability-relative portfolios where both duration and currency controls are important to avoid asset-liability mismatches. The BMO range has gathered some £117m AUM since launch in November 2015 (inflows of £3m per month on average). This compares to iShares' CRPS size of £824m since launch in September 2012 (inflows of £12m per month on average). As the advantages of bond investing with ETFs become more apparent (secondary liquidity, transparent exposure, daily disclosure of underlying), we expect increasing price competition and greater nuance within the most popular strategies. ETFs mentioned ZC1G BMO Barclays 1-3 Year Global Corporate Bond (GBP Hedged) 0.17% TER ZC3G BMO Barclays 3-7 Year Global Corporate Bond (GBP Hedged) 0.17% TER ZC7G BMO Barclays 7-10 Year Global Corporate Bond (GBP Hedged) 0.17% TER CRPS iShares Global Corporate Bond (Unhedged) 0.20% TER CRHG iShares Global Corporate Bond (GBP Hedged ) 0.25% TER (All ETFs mentioned are UCITS ETFs listed on the London Stock Exchange)
What are CoCos? Following the 2008 financial crisis, banks had difficulty issuing traditional debt securities, and had to sit on a large amount of capital to ensure their balance sheet strength was maintained. CoCos were created as the issuing banks flexible friend. This is because are designed to absorb losses when the balance sheet of the issuing banks weakens below a threshold level. Losses can be absorbed by the CoCo converting into equity or suffering a write-down of its principal value making it more flexible than traditional bank securities. To offset the risk of loss, CoCos are issued with a higher coupon than traditional bank bonds. Accessing CoCos Whilst bond funds may include CoCos, direct access to CoCos as a targeted allocation was previously only available to institutions who could meet minimum issuance sizes from one or more issuer. By accessing CoCos using an ETF, the minimum investment drops to $100, and the ETF is diversified across 29 CoCos from 24 different issuers. Why include CoCos in a portfolio? Convertibility into the issuing bank’s shares means that CoCos provide an exposure that has both bond and equity-like characteristics. When there is higher risk of balance sheet stress, CoCo's behave more like equities. When there is lower risk of balance sheet stress, CoCo’s behave more like bonds. CoCos' moderate correlation to equities and low correlation to Corporate and Government Bonds makes them a useful diversifier from a portfolio construction perspective. Fig.1. Correlations to major asset classes  Bigger income & better credit quality CoCos have an attractive income to reward risk taken, but a better quality credit rating compared to traditional High Yield Bonds. Fig.2. Income Profile  Fig.3. Credit Profile  Furthermore, in terms of counterparty risk, CoCos are only issued by large banks that are well regulated with high capital ratios. How about performance? CoCos have outperformed EUR bonds and equities, both excluding and including Financials exposure. Fig.4. Total Returns  CoCos are positioned between equities and bonds in respect of realised volatility, but with better risk-adjusted returns. Fig.5. Risk-Return  In summary, CoCos have offered solid risk-adjusted returns (Sharpe Ratio), and have a low correlation to bonds from a diversification perspective and a higher income with better credit quality relative to traditional high yield bonds.
October saw a sharp one month loss for global sovereigns owing to inflation fears, raised interest rate expectations and declining Central Bank appetite for QE. In the US, prospects of a December Fed Rate hike saw 10 year yields clime 30bp on month and 76bp from summer lows to 1.26%, whilst stronger growth numbers raised inflation expectations and positive performance for TIPS. The USD performance for inflation-linked treasuries was -0.33% (LSE:ITPS), compared to for -1.32% (LON:IBTM) for conventional treasuries. In the EU, fears over the ECB’s commitment to QE contributed to the sell off. The EUR performance for inflation-linked Euro government bonds (LSE:IBCI) was -1.78%, compared to for -2.14% for conventional Euro government bonds (LSE:IEGA). In the UK, the inflationary potential from Brexit, and vanishing expectations of any further BoE rate cuts on stronger economic growth led to a gilts sell off. The GBP performance for inflation-linked gilts (LSE:INXG) was -0.65%, compared to -3.92% for (LSE:IGLT) for conventional gilts.  |
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