The other entrants in the top 15 European fixed-income ETF table (Figure 1) represent a broad mixture of bond funds - from ETFs tracking various maturity segments of the Euro MTS indexes, to the iBoxx Euro Sovereigns 3-5 year Index (an inflation-linked fund) and a number of funds in Germany and Switzerland tracking only domestic sovereign issues. Recent months have seen a sharp divergence in bond yields between the less creditworthy Eurozone governments and the better and lowest-yielding Germany, and so specific country versions offer a cleaner way of differentiating between the creditworthiness of issuers.

Does this mean we will see more ETFs tracking the bonds of other countries/sovereigns, particularly from the lower-quality, higher-yielding end of the spectrum?

Assets By Issuer

Figure 4. European Fixed-Income ETF AUM By Issuer

Source: Deutsche Bank. Reuters

The main players in the European fixed-income ETF market are familiar names - BGI has a combined 37% market share and is market leader, though its share is much smaller than its dominant (88%) position in the U.S. fixed-income ETF market. With Lyxor having a 28% share and Deutsche Bank 23%, three companies dominate the market and there is a good level of competition amongst product providers.

As in the overall ETF market, Deutsche Bank's rise up the tables is impressive, considering that it only started operating just over a year ago, and it is worth mentioning an area where it (and EasyETF) have stolen a lead on competitors. The credit markets have been the centre of the action for fixed-income investors over the last year, as spreads have widened significantly from historic lows at the beginning of 2007. db x-trackers' launch of long and short ETFs for the three main components of the iTraxx indexes has enabled retail investors to access the credit derivatives market for the first time, and to express both bullish and bearish views (the EasyETF funds offer long exposure only to two of the iTraxx indexes). The credit ETFs have raised funds quickly, and are well on the way to their first billion euros in total, having started only late last year. No doubt reflecting their relative complexity, they are also higher-margin funds than the traditional fixed-income ETF - DB prices its iTraxx crossover funds at 24 basis points, and EasyETF charges 30 bps, whereas most of the largest European fixed-income ETFs have charges in the 15-20 bps range.

Here again, we see product innovation in Europe when compared with the U.S. market, where there are no equivalent funds (although some are on the market).

While these funds have filled an obvious gap in the market, there are plenty of other areas for product providers to exploit. Domestic currency fixed-income ETFs for emerging market countries are an obvious next step. There are also almost no fixed-income inverse funds, and as we are at relative lows for interest rates historically, it would seem to make sense to add funds for investors to take a bearish view. And what about constant maturity/duration ETFs? Ameristock/Ryan has launched such funds in the U.S., though with only modest success to date, but will someone else have a go at overcoming the "lumpiness" of fixed-income indexes (as bonds shorten in maturity and fall out)?

All in all, the fixed-income market has been an area of dynamic activity for European ETF issuers, and the sector is beginning to grow very quickly. Will it overtake the U.S. fixed-income ETF market in 2008? Watch this space.

*Deutsche Bank, Fixed-income ETF Liquidity Trends, 3 April 2008

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