It’s been a tough year for the bond bears. Government bond yields in France and Germany have just hit record lows, while Japanese 10-year yields are back below 1%. US Treasury bond yields are either at record lows or not far from them (at longer maturities). Meanwhile, desperate for yield, investors have pushed the prices of any funds offering exposure to higher-income assets – corporate bond and emerging market debt ETFs, for example – to new highs.
In the US, investors in the ProShares UltraShort 20+ Year Treasury ETF (NYSE Arca: TBT), a US$4.5 billion fund that offers a double inverse daily return on long Treasury bonds (and which continues to attract bearish investors, with nearly US$1.5 billion of inflows so far this year) have suffered a 35% loss in 2010 as yields have gone down, rather than up.
What are the implications of this steady decline in yields for the European fixed income ETF market? How are investors coping with the falling returns from their bond investments, and is there anything ETF product developers can do to soften the blow?
According to Claus Hein, head of Lyxor ETFs in the UK, one pronounced trend amongst investors so far in 2010 has been capital preservation rather than a search for yield. “We’ve seen steady inflows this year into the EuroMTS AAA government bond ETF that we launched late last year, and the fund has reached over €600 million in size,” he said. “The fund invests only in the government debt of eurozone countries with an AAA-rating: France, Germany, Netherlands, Austria and Finland. Investors have been moving out of the eurozone countries where sovereign ratings have been under pressure.”
Alex Claringbull, senior fixed income portfolio manager at BlackRock, highlights the same theme.
“A few years ago investors didn’t pay much attention to the diversity of issuers within broad European government bond benchmarks. They saw the region as a harmonised whole under European Monetary Union. But over the last year people have realised that what they thought was a simple interest rate product has ended up as a half rates, half credit risk product, as yield spreads have diverged. The relative performance of different bond indices tracking European government bonds has diverged as well, depending on what’s in the index.”
“We offer iShares government fixed income ETFs tracking German bonds only, others covering five countries – Germany, France, Netherlands, Italy and Spain – and a third group covering the whole European government bond sector. Unsurprisingly, the German bond funds have performed best over the last year. It’s important that clients fully understand what underlying country exposures they’re taking on when buying a government bond ETF,” said Claringbull.
The decline in government bond yields in the major markets has been pushing investors into other parts of the fixed income sector, as well as other asset classes altogether, providers say.
“Over the last 12 months we’ve seen a lot of interest from clients using ETFs to get back into equities,” said Manooj Mistry, head of UK ETFs at db x-trackers, “particularly amongst private banks and wealth managers. Within fixed income, there’s also been competition from other delta-one products such as futures and swaps. However, we’ve seen healthy demand for our ETFs offering short exposure to government bond indices, particularly our short iBoxx € Sovereigns ETF, which has over €750 million in assets.”
iShares’ Claringbull makes a similar point. “Investors have been focussing on the relative value between fixed income and equities. As bond yields move lower the cheaper equities look by comparison.”