The iBoxx EUR Sovereigns Eurozone TR Index measures the performance of the investment-grade-rated eurozone government-bond market. The index covers all maturity buckets above one year. Eligible bonds must have a minimum outstanding of EUR 2 billion. Bonds are weighted according to their outstanding amount. Issuing countries are required to have an investment-grade rating, calculated by Markit as the average rating from the three main rating agencies.
The four largest eurozone issuers (Italy, France, Germany, and Spain) typically account for 80% of the index's value. The breakdown by maturities is reflective of government bond issuance patterns across the eurozone.
The index is calculated on a total-return basis using daily closing prices. Prices for all bonds are provided by 10 major financial institutions and are then consolidated for index calculation purposes. The index is rebalanced monthly. Coupon payments are held as cash until rebalancing and then reinvested.
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The annual ongoing charge for this ETF is 0.15%. This compares positively to actively managed peers. 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.
The ETF has a very tight historical tracking record. Tracking difference – that is the difference in returns between the fund and index – routinely matches the ongoing charge of 0.15%.
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Xtrackers uses physical replication to track the performance of the index. From inception until September 2016 the fund was swap-based.
The ETF managers use stratified sampling. The index is broken down into sections, each representing key risk factors, such as duration, currency, country, rating, and sector. The managers then choose bonds included in the index that mimic the risk profile of each section. The aggregate result is a portfolio that represents the index's overall risk profile, while allowing the ETF manager to avoid purchasing bonds that suffer from illiquidity.
The fund manager may make use of cash and index futures positions. However, the combined weighting of these components would be routinely kept below 1% of the fund's net asset value.
For its suite of physical ETFs, Xtrackers may engage in securities lending. The ETF may lend out a maximum of 50% of its portfolio. Deutsche Bank Agency Securities Lending acts as the lending agent. All transactions are over-collateralised and the securities taken as collateral tend to be top-rated government bonds and blue-chip stocks. Lending revenue is split 70/30 between the ETF and the lending agent, respectively. Xtrackers discloses the details pertaining to securities lending for this ETF on its website.
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The eurozone government bond market is highly liquid, and opportunities to add value over a standard benchmark are limited over the long-term. As a result, an all-issuer, all-maturity and low-cost index-tracking approach such as the one offered by Xtrackers Eurozone Government Bond ETF has become the default option for investors seeking a core holding for this market exposure.
ETFs providing exposure to the eurozone sovereign bond market track indexes from different providers, and so there may be slight differences in bond selection. However, this has not translated into discernible variations in performance between passive peers over recent years. Risk-adjusted returns for passive funds in this Morningstar Category--which includes many active funds--typically rank in the first quartile or upper areas of the second quartile over multi-year periods. There may be some volatility in returns over the short-term. However, being an all-issuer/maturity mandate helps iron things out over the mid and long-term.
The ETF tracks an all-maturity index covering both core and peripheral issuers with an investment-grade rating. The ETF comes with an ongoing charge of 0.15%, which is competitive relative to active peers for this market exposure.
We remain highly confident that a passive approach to investing in this market is likely to deliver returns above the Morningstar Category average over a full market cycle.
The fund retains a Morningstar Analyst Rating of Gold.
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Monetary policy settings in the eurozone 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 negative deposit rate. As the eurozone economy slows and inflation continues to show no signs of picking up, further cuts to the deposit rate and another round of asset purchases are expected. 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.
The ECB’s monetary policy stance has pushed eurozone government bond yields to historical lows, with the most creditworthy issuers such as Germany and the Netherlands able to raise funds at negative rates for very long maturities.
Also, the policy stance has allowed for a strong compression in core-peripheral bond spreads and the minimisation of sovereign risk-related volatility. Specific country risks remain, particularly regarding Italy. Episodes of political tension would prompt safe-haven flows to core bonds. However, with the ECB on close watch, a return to the full-blown market tensions experienced back in 2012 now looks like a tail risk. All the while, an all-issuer eurozone government mandate allows for offsetting forces between peripheral and core debt at fund level.
In the long run, investors may want to factor in a scenario of higher interest rates, which would erode the price of fixed income investments, particularly those with longer maturities. However, this remains a distant prospect.
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Most providers have ETFs providing exposure to the broad eurozone government bond market. The most popular in terms of assets under management are by iShares, Xtrackers, and Lyxor. ETFs providing the same bond market exposure may track different indexes, and so there may be variations in the bond/country selection criteria. However, in the case of EUR-denominated government bonds, the differences in the risk/return profile between mainstream benchmarks are minimal.
The physically replicated iShares Core Euro Government Bond ETF (ongoing charge 0.09%) and Lyxor EuroMTS All-Maturity ETF (0.165%) also track benchmarks that restrict exposure to investment-grade-rated issuers.
Alternatives from other providers such as Amundi, State Street or Vanguard lag in AUM terms. As of this writing, the ETF with the lowest ongoing charge is Amundi Prime Euro Govies at 0.05%.
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