Simple ideas often make great ETFs

Jul 18th, 2013 | By | Category: Fixed Income

By David Stevenson – 

Simple ideas often make great businesses – it’s the same with exchange-traded funds (ETFs). Precisely because the ETF sector is so fast-moving and innovative, every once in a while a simple, smart, well-researched idea toddles along, sticks up its hand and then gets deluged with lots of money.

Simple ideas often make great ETFs

David Stevenson: Simple ideas often make great ETFs.

Cue Guggenheim’s range of BulletShares ETFs in the US. Linked to a range of indices developed by Accretive Asset Management, these corporate and high-yield bond ETFs take the simple idea of a target-date lifestyle fund and then turn it on its head – you want diversified income but you also want to know that you’ll get your money back at a set date in the future, then why not invest in a BulletShares ETF with the requisite maturity date?

It’s a devastatingly simple idea that caters to a host of portfolio strategies (bond laddering, asset/liability matching etc) and it is to both Guggenheim and Accretive’s credit that it has harvested a ton of money – and prompted rivals such as iShares, with its iSharesBonds brand, to jump into the market in response. It’s also no surprise that a big index provider (namely Nasdaq OMX Global Indexes) has got in on the game, teaming up with Accretive to promote and grow the BulletShares defined-maturity index offering.

There are of course a number of obvious drivers for this range’s success, not least what I call the ‘certainty principle’ – if you want to understand this principle, take a look at how our UK listed retail bond space has absolutely exploded in size. The giveaway is numbers like 5 or 6, i.e. 5 or 6-year fixed maturities.

The years in question refer, of course, to the maturity of the UK retail bonds issued on the London Stock Exchange. I, an impoverished British investor looking for an income, can invest in  UK PLC’s latest retail bond issue paying between 4.5 and 6% per annum with a maturity…this is the really important part…. in 5 to 6 years’ time. Price £100 per bond. The language is simple and echoes that used by savings bonds issuers on the high street.

The key point is my certainty principle – in six years I get my £100 per bond back, allowing me, the investor, to properly cash flow my investments. In my humble experience, investors in the mass market LOVE certainty and HATE uncertainty.

Smart egg heads can explain until the cows come home about the risk/return trade-off and investors will look straight past them and focus on that word…RISK i.e. uncertainty. “Gosh that sounds a bit worrying. I’ve worked hard to earn that small pot of capital, so I don’t want to risk it on some uncertain outcome or return”. You can shout at them until you are blue in the face that “we live in a low-returns world where you need to increase returns in order to enjoy your retirement, and that means increasing some risk opportunistically…” but trust me when I say that they’ll steadfastly ignore you!

Flash forward to Guggenheim and its NYSE-listed BulletShares bond ETFs. Currently, if I invest in its 2020 Corporate Bond ETF I know the following with some degree of certainty.

1. I’ll get my investment back in 2020 as the underlying corporate bonds mature (assuming no defaults)

2. My expense ratio is 0.24% per annum, which is very reasonable compared to actively managed funds

3. My weighted average yield to maturity is 3.75% per annum, which is ok and a heck of a lot better than the average long-duration savings account

4. The biggest single holding is Bank of America (at just over 2%) with A-rated bonds in the large majority

That’s it. Nice and simple, with assets under management of $45 million. Yet if we wind the dial back to the 2014 maturity date, the yield drops to a rather less exciting sub 1%, but assets shoot up to $289 million.

The success of Guggenheim’s BulletShares shows that simple ideas can work and I’d confidently predict that sooner or later someone in Europe will copy this phenomenon. Equally, I’d also expect to see even more innovation within the fixed income ETF space on our side of the pond – too many bond trackers are targeted exclusively at institutional investors. Why doesn’t someone, for instance, think about coming up with an ETF that targets our own UK retail bond space, giving private investors the benefit of underlying securities diversification? There’s already a series of indices on the shelf just waiting to be used, the FTSE ORB Index Series.

And if institutional innovation is all we are going to get in Europe (!), then maybe somebody should copy the success of the SPDR Blackstone / GSO Senior Loan ETF (SRLN) which has garnered $400 million in assets in less than four months since its launch – this echoes in some respects a UK-listed closed-end fund called Carador income which has a similar mandate and is also actively managed by Blackstone GSO and has gathered a big stash of money over the years.

Why can’t ETF issuers think ahead of the curve and not just invent yet another emerging markets debt fund, this time with a hint of currency hedging? I think investors want either new concepts that access genuinely refreshing income ideas, preferably within a fast-evolving space, or, if nothing else, they want simply-executed ideas that resonate with the mass market!

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