ETFs: the perfect storm

Nick Sudbury looks for safe havens in the government bond sector

Global equity markets have had a tumultuous few months with the problems in the eurozone and slowing economic growth sending share prices tumbling. The volatility has prompted many investors to switch into the relative safety of government bonds. 

Research by Morningstar shows that three of the top five global fixed income ETFs based on quarter-to-date estimated net inflows track short-dated US and German government debt. They are: SPDR Barclays Capital 1-3 Month T-bill (BIL), iShares eb.rexx GovGer 1.5-2.5 (EXHB) and iShares Barclays 1-3 Year Treasury Bond (SHY). 

Ben Johnson, director of European ETF research at Morningstar says that the driving force behind these inflows has been a general flight to safety. “For all of the talk of the need for a new risk-free benchmark in the wake of the recent downgrade of the US credit rating by Standard and Poors, it would seem to me that many continue to view treasuries as a safe haven.”

 

Healthy returns 
The general nervousness in the markets has meant that the top performing government bond ETFs have produced some spectacular long-term returns. Investors in iShares eb.rexx GovGer 10.5 plus (EXX6) have done especially well with a five-year gain of approximately 82%. 

EXX6 provides exposure to euro denominated German government bonds with a minimum remaining time to maturity of ten-and-a-half years. Most of the five-year gain is attributable to the local market return of 38.5%, although UK based investors have also benefitted from a 31.45% currency return. 

Blanca Koenig, fixed income specialist for BlackRock’s ETF business, iShares, says that the performance is due to the appreciation of the euro against the pound, a positive price effect as a result of falling yield levels and the annual interest paid on the bonds. 

“German government bonds are understood to be the safest government bonds in the eurozone. The average maturity of EXX6 is currently 21 years and the yields in this part of the yield curve fell from approximately 4% at the end of August 2006 to 2.95% at the end of August 2011. This helped to produce a strong local market return over the period.” 

There are also several other iShares ETFs tracking different maturity buckets in the same index and they too have produced strong gains. One such is iShares eb.rexx GovGer 1.5-2.5 (EXHB) which is up 55.55% over 5 years with a return of more than 9% in the last 12 months. This is also one of the largest ETFs in the sector with AUM of just over £1bn. 

 

Star spangled banner
Another apparent safe haven with a good long-term track record is US Treasury bonds. The two best performing ETFs in this part of the market are iShares Barclays 7-10 Year Treasury (IEF) and iShares Barclays 20+ Year Treasury Bond (TLT). Both trade on the NYSE ARCA and have five-year returns of just over 75% despite the recent downgrade in America’s AAA credit rating.