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Bond of the Week: 6 October 2009

iShares broaden coverage of the UK bond market with a new "ex-financial" sterling bond ETF................


The problem with most bond funds lies with the charges. Whilst there are clear benefits for investors using the expertise and diversification benefits of a fund, total expense ratios (TERs) of between 1 - 1.5% on traditional managed funds effectively wipe out any advantage. This is particularly true for fixed income assets in a low interest rate environment where the estimated yield of the underlying assets may only be 3 to 6%.

ETFs are a popular solution for this problem. In the US, the instruments have taken the investment world by storm, offering a low cost method for wealth managers and investors to lock into a sector or an asset class. Charges for ETFs are generally in the region of 0.2%, a reasonable price to pay for the benefit of a structured and diversified portfolio. In the fixed income sector, US investors can choose from a wide range of funds from competing providers covering most of the asset-class sub-sectors one can imagine; Treasury, Municipal, Mortgage Backed, Corporate, Emerging Market etc etc.

The sterling bonds markets are rather less deep and diverse than their US equivalents. This is not surprising given the respective size of the two economies and partly due to this, the choice of fixed income ETFs for sterling-based investors is a little more limited. However the iShares series of ETFs offers a reasonable line-up with ETF available for gilts, index linked gilts and corporate bonds.

Until recently, the only available corporate bond ETF was the iShares Sterling Dated Corporate Bond ETF (SLXX). This ETF tracks the IBOXX liquid Sterling bond index. However, this index is notable for the predominance of bank and financial sector issues, and in particular the number of subordinated issues.

We last looked at the SLXX in our Bond of the week feature of the 9th June, noting that we would like to see better segregation and stating that "An investment grade GBP "corporates only" ETF would make a great investment vehicle whilst subordinated instruments could find a home in GBP denominated high-yield ETF."

iShares have come up with the goods - their fixed income team has launched the iShares iBOXX £ Corporate Bond ex-Financial (ISXF), which strips out the large number of bank issues (often subordinated) that make up an alarming 47% of the SLXX.

This new ETF is a useful tool, for UK investors. At present, the new ex-financial ISXF offers a yield of 5%, and the top ten holdings are as follows :

  Security Coupon Maturity Price Country % Weight
1 WAL-MART STORES 5.625% Mar 27 2034 5.62 27/03/34 107.80 United States 3.20
2 E.ON INTER FIN 6.375% Jun 7 2032 6.38 07/06/32 115.51 Netherlands 2.95
3 GLAXOSMITHKLINE 5.25% Dec 19 2033 5.25 19/12/33 103.32 United Kingdom 2.39
4 VODAFONE GROUP 5.375% Dec 5 2017 5.38 05/12/17 102.87 United Kingdom 2.38
5 SCOTTISH & SOUTH 8.375% Nov 20 2028 8.38 20/11/28 136.12 United Kingdom 2.29
6 FRANCE TELECOM 5.25% Dec 5 2025 5.25 05/12/25 99.85 France 2.14
7 TELECOM ITALIA 6.375% Jun 24 2019 6.38 24/06/19 101.21 Italy 2.11
8 TELEFONICA EMIS 5.375% Feb 2 2018 5.38 02/02/18 102.30 Spain 1.93
9 BAT INTL FINANCE 6.375% Dec 12 2019 6.38 12/12/19 107.22 United Kingdom 1.79
10 DEUTSCHE TEL FIN 6.5% Apr 8 2022 6.50 08/04/22 107.39 Netherlands 1.76

The new ISXF ETF has a total of 122 holdings, making for an average maturity of 13.5 years. Duration (effectively the weighted average  of all the cash flows) stands at 8 years and the fund distributes a semi-annual coupon. You can read the full details on the link here

My view: The ISXF is a useful addition to the iShares line up and investors who plan to make their first steps into the fixed income asset class could do a lot worse than start right here. The subordinated debt has been stripped out, and thus I expect this ETF to be slightly less volatile than its broader SLXX cousin, but time will tell. It will be interesting to track the performance of the two over the next year or.

Mark Glowrey    


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