Corporate bonds are generally highlighted as an important part of investment portfolios. Investors have been traditionally attracted to corporate bonds for the expected steady income at higher yields vis-à-vis government bonds, and the perceived lower risk profile vis-à-vis equity. In fact, since the start of the eurozone sovereign crisis, one could argue that investment-grade corporate bonds have also been seen as a less risky alternative to debt issued by the eurozone peripheral countries. This has been facilitated by the fact that the vast majority of investment-grade corporate debt issuers tend to be large-cap corporations located in developed economies.
However, accessing the corporate bond market directly as a private investor can prove a very trying task. For starters, most operations are conducted over-the-counter and are targeted to an institutional client base able to meet generally large minimum dealing sizes. An additional hurdle for individual investors is the dearth of information available on corporate bonds; at least relative to the constant stream of media coverage enjoyed by equity markets, which has now also extended to government bonds. And yet, despite all these very real hurdles, gaining exposure to the corporate bond market remains an advisable course of action for investors loyal to the notion of diversification.
Plenty of Room for Growth, with ETFs a Key Driving Force
This is where ETFs come in handy. Indeed, although still very much the preserve of the European institutional investor community, corporate bond ETFs allow information-starved individual investors, as well as IFAs advising them, easy access to this market. It would be unwise to assume that the growth of the corporate bond ETF segment in Europe may be driven by retail/IFA demand in the near term. But it would be equally unwise to dismiss the long-term growth potential for this fixed income ETF segment from a European retail customer base which is to become increasingly income-seeking in nature by the sheer force of demographics.
In fact, it can be argued that the impact of demographic trends in shaping investors' attitudes has found a very valuable ally in the economic crisis. Some of the basic notions of the European welfare state have been badly shaken by the economic/financial fallout of the past few years. Pension reform is now all the rage across the continent, with governments of all persuasions sending the message that old age state-funded pension provision won't be as generous in the future. The seeds for a significant growth of private pension plans are being planted as we write, and with them we can expect growing interest on income-generating investment strategies. This bodes well for the corporate bond market in general and for corporate bond ETFs in particular.
The European corporate bond market experienced significant growth in 2009 as a direct result of the seizure of traditional banking lending channels in the wake of the collapse of Lehman Brothers. Corporate bond issuance levels have remained around their long-term historical average in 2010 as normalisation of banking lending has proceeded at a slower pace than would have been desirable in an economic recovery environment. This, together with the aforementioned favourable comparisons to some government bonds, not to mention the generally low yield environment in which we still operate, may allow for corporate bond issuance to remain above average for the foreseeable future.
The increase in corporate bond issuance since the onset of the crisis has gone hand in hand with a substantial increase in government bond issuance. Credit spreads (i.e. the yield difference to lower risk assets such as government bonds) shot up significantly in late 2008 and early 2009, only to deflate thereafter, though still remaining well above pre-crisis levels. Ongoing tensions in the eurozone government bond market and concerns about the strength of the recovery continue to preclude full corrective action. Within the corporate debt market, debt issued by financial corporations usually has the highest credit spreads, followed by industrial and utility companies.
Increasingly Competitive European Market for ETFs Tracking Corporate Fixed Income
According to Morningstar data collated as of mid-January 2010, the number of EUR-denominated corporate bond ETFs stands at 12, with combined assets under management (AUM) of EUR 5.86 billion and carrying an average total expense ration (TER) of 0.20%. As per GBP-denominated corporate bond ETFs, we find three products, with combined AUM of GBP 1.29 billion, also charging a TER of 0.20% on average.
As we write, iShares is the undisputed market leader in this particular segment, taking up over 83% of AUM for EUR-denominated corporate bond ETFs and an even higher 98% of AUM for GBP-denominated vehicles. In fact, the iShares Markit iBoxx Euro Corporate Bond ETF (IBCX), with AUM just over EUR 3.5 billion, and the iShares Markit iBoxx GBP Corporate Bond ETF (SLXX), with AUM just shy of GBP 1.125 billion, are the most popular ETFs in their categories by sheer virtue of their long run in the marketplace (e.g. they were launched in March 2003 and March 2004, respectively) without facing any direct competition.
However, since 2009 we have seen a proliferation of corporate bond ETFs launches, particularly EUR-denominated, from key ETF providers in the European market (e.g. Lyxor, db x-trackers, Amundi, ETFlab). This has been a very welcome development. First and foremost, it provides choice for investors, who now can gain exposure to the corporate bond market both using physical- and swap-based ETFs. But perhaps more importantly, increased competition has also sparked an incipient rush for innovation, with investors now also given the choice of segmentation, both in terms of industry type (e.g. ETFs offering exposure to the whole market or restricted to financial and non-financial corporate bonds) as well as maturity (e.g. ETFs offering exposure to corporate bonds with maturity in the 1-5y bracket).
As mentioned, we at Morningstar reckon that room for growth for the European corporate bond ETF market is ample. On that premise, we would expect increased inflows as well as new products to meet the increasing demand.
