The Markit iBoxx EUR Liquid Corporates 125 Mid Price TCA Index measures the performance of the most liquid segment of the euro-denominated investment-grade corporate-bond market, irrespective of issuing country. Liquid indexes are subsets of broader iBoxx indexes. (Note: The ETF tracked the even more restrictive Markit iBoxx Euro Liquid Corporates Overall Index from inception until September 2015. This index contained only 40 bonds.)
Bonds must have a minimum remaining maturity of two years and minimum outstanding of EUR 750 million. The maximum number of bonds in the index is 125, with no more than three from the same issuer. The index is weighted by market capitalisation.
Index calculations are based on midprice quotes provided by contributing banks. The index is rebalanced monthly. Bonds with maturity falling below two years are excluded from the index at rebalancing.
The index typically shows a 40/60 split between financials and nonfinancials. Eurozone issuers tend to account for 70%-75% of the index's value and non-eurozone issuers for 25%-30%.
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The annual ongoing charge is 0.20%. This is at the top end of what is a tight fee range for ETFs providing exposure to the euro-denominated corporate-bond market. But even at 0.20%, the ETF compares positively with the median clean share class fee for funds in its category (that is, inclusive of active funds).
Additional costs potentially borne by investors and not included in the ongoing charge include bid-offer spreads and brokerage fees when buy/sell orders are placed for ETF shares.
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Lyxor uses synthetic replication to track the Markit iBoxx EUR Liquid Corporates 125 Mid Price TCA Index. Lyxor uses the unfunded swap model. The ETF buys a basket of securities--commonly referred to as the substitute basket--from Societe Generale while simultaneously entering into an over-the-counter total-return swap agreement to receive the performance of the index (net of fees) in exchange for that of the substitute basket.
The substitute basket for Lyxor's fixed-income ETFs is typically made up of euro-denominated investment-grade fixed-income securities, both government-backed (that is, sovereign, regional, agency) and corporate. The full composition of the substitute basket is disclosed daily in Lyxor's website.
According to UCITS regulations, individual counterparty risk exposure is limited to 10% of the fund's net asset value at any point in time. However, Lyxor targets zero swap exposure per individual ETF daily, while in practice the swap level tends to be negative, thus effectively meaning overcollateralisation. For their suite of synthetic ETFs, Lyxor does not engage in securities lending with the substitute basket's holdings.
This ETF does not distribute dividends.
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Taking a low-cost passive investment approach to the market of EUR-denominated corporate bonds can deliver a good returns outcome over the long-term relative to most active funds. However, the benchmark tracked by Lyxor ETF Euro Corporate Bond provides a too-restrictive representation of the market, focusing on a small section of highly liquid large-cap issuers.
The trade-off relative to broader-based benchmarks is one of yield, as large-cap corporations usually hold more pricing power in the market. The strict focus on liquidity and the large-cap bias may serve this exchange-traded fund well at times of stress for the underlying. However, for investors seeking a core long-term holding in this market, the investment proposition provided by this ETF errs on the defensive.
The fund’s risk/reward profile has been mixed over the past three years, and the fund is likely to do better at times of market stress when issuer credit quality becomes more of a driver of returns. Compared with peers in its Morningstar Category, which include passive and active funds, the returns of this ETF have come in line with the category average on a risk-adjusted basis.
The ETF displays a good tracking record. The ongoing charge of 0.20%, although at the top end of the fee range for passive funds providing this market exposure, is competitive relative to active mandates.
Overall, it does what it's supposed to do, and investors with a particularly low risk tolerance or specifically seeking a quality-biased corporate bond holding may find it suits them well. Ultimately, however, we remain unconvinced that the investment proposition as defined by the index can consistently outperform the average peer over a full market cycle given the structural biases of the portfolio.
The fund retains a Morningstar Analyst Rating of Neutral.
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Investor interest in the corporate bond market has grown substantially since 2008. Yields have come down across the maturity and credit spectrum, prompting a substantial compression of spreads relative to government bonds. Bonds issued by financial corporations usually have the highest credit spreads, followed by industrials and utilities. All the while, there has been an increase in bond issuance, as corporations take advantage of the low yield environment to raise funds at very favourable terms.
Demand for EUR-denominated corporate bonds has found fundamental support on the European Central Bank’s supportive monetary policy. Aside from keeping interest rates at historical lows, the ECB’s programme of asset purchases has included nonbank investment-grade corporate bonds. In addition, the ECB is fully committed to the provision of liquidity to the eurozone banking sector at very favourable conditions.
Monetary policy settings remain very accommodative and with a bias for further stimulus. As we write, the ECB’s policy remains underpinned in zero-bound interest rates--including a deposit rate of negative 0.40%. Further reductions to the deposit rate and another round of asset purchases are not ruled out to boost inflation and prop up economic growth. Meanwhile, in March 2019, the ECB announced a new round of long-term refinancing operations to ensuring favourable bank lending conditions. The programme will run from September 2019 until March 2021.
In the mid-to-long run, however, investors must factor in a scenario of higher interest rates, which can erode the price of fixed-income investments, particularly those with longer maturities. However, if higher rates come alongside a scenario of stronger economic growth, then this can be ultimately supportive of corporate fundamentals and provide a floor to corporate bond valuations.
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When considering an ETF for this market exposure, investors should pay special attention to the investment proposition defined by the various benchmarks. There are many variations in construction rules even between indexes from the same provider. In general terms, there is a trade-off between liquidity and yield, meaning that indexes applying tight criteria may miss out on yield but would tend to be less volatile during times of market stress.
The two market-leading ETFs in AUM terms are the physically replicated iShares Core Euro Corporate Bond (ongoing charge 0.20%; tracks a Bloomberg Barclays index) and iShares Euro Corporate Large Cap Bond (0.20%; tracks a Markit iBoxx liquid index). Of the two, the iShares Core ETF provides the broadest representation of the market.
Other ETFs tracking the Bloomberg Barclays benchmark include Xtrackers EUR Corporate Bond (physical; 0.20%), SPDR Barclays Euro Corporate Bond (physical; 0.20%) and Vanguard EUR Corporate Bond (physical, 0.12%).
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