Inflation-Linked Bond ETFs – Time To Buy?
December 14, 2008
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What options are available for the European ETF investor who wants to gain access to this market sector? I've summarised the key European inflation-linked ETF offerings in the table below (details are taken from the October 2008 BGI Global Handbook).
The market coverage of these ETFs, with country funds for the US and UK, three Eurozone and two global funds, reflects the make-up of the global inflation-linked government bond market. Taking the Barclays World Government Inflation-Linked Bond Index as an example, three issuers, the US (38%), UK (22%) and France (15%) dominate, representing three-quarters of the overall market by capitalisation. Italy (8%) and Japan (7%) follow, with the remaining issuers (Canada, Sweden, Germany, Greece, Australia) contributing only 10% in total. There are several emerging market inflation-linked government bond issuers, but to date their bonds are not tracked by ETFs.
The Eurozone indices, accordingly, are heavily biased to the inflation-linked bonds of France and Italy. The current Barclays Euro Government Inflation-Linked Bond Index factsheet has the following country weights: France (60%), Italy (32%), Germany (4%), Greece (4%).
So, at present, those investors wishing to invest in a particular country's inflation-linked bonds cannot do so outside the UK and the US markets. Perhaps in due course other country ETFs will follow.
The issuer line-up currently consists only of the top three names from the European ETF market, although both EasyETF and CASAM have recently announced their intention to launch inflation-linked bond ETFs.
Index replication methods across the existing funds differ—both Lyxor and db x-trackers follow the swap-based route, whereas iShares uses physical replication in all its funds, except for its Global Inflation-linked Bond ETF, which relies on an optimised method.
European inflation-linked bond ETF assets under management, at around $1.6 billion, are still very small when compared to the overall fixed income sector, which has around $35 billion in invested funds.
So, in summary, the inflation-linked bond market has recently seen a marked improvement in its attractiveness to investors, particularly when compared to fixed-rate investments. Wherever one stands in the deflation/inflation debate, it's worth reminding oneself that in certain markets a significant period of deflation is already priced in. The European investor has a reasonable range of funds available to choose from, although some more country funds might not go amiss. And, since this is an area of the market where ETFs' ability to offer diversification at a reasonable cost is particularly useful, this seems a sector that is destined to grow its assets substantially further in 2009.
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