As the tumultuous and historic year of 2008 draws to a close, one sector of the European exchange-traded fund market has boomed: fixed income. Even as equities have wilted, the fixed-income ETF sector has grown, reaching 27.4% of all European ETF assets by end-November, up from 16% at the beginning of 2008.

There are a number of factors driving this ascendance. One, of course, is simple performance: Bonds have performed better than equities (or commodities, for that matter), so their share of total assets under management has risen sharply.

Bonds have also been the asset class of choice for many investors, as the result of a flight to safety from riskier assets such as equities, and as investors flock to any safe instrument offering a fixed return.

Yet, below the surface, the performance of the different bond market sectors has been remarkably diverse. This feature reviews the different European bond ETF categories, their 2008 year-to-date price return (i.e., excluding interest income), and the year-high NAV and year-low NAV (to give a feel for the variability of returns). The gross redemption yield as at 24 December, where available, is also given.

We have selected a broad cross section of European ETFs from the given fixed-income categories, excluding money market funds, whose returns are largely predictable (reflecting the average return on cash deposits during the year), and also inflation-linked bonds, which we covered in a recent feature.

The ETFs chosen in the table have been selected as a representative sample of the different areas of the bond market, but are not meant as an exhaustive list.

Government Bond ETFs

Government bond investors enjoy a variety of choices from a number of different providers, including funds focused on different sovereign markets and different spots on the yield curve.

Bonds issued by the leading Eurozone sovereigns, the US and UK governments, added another leg to a multiyear bull market in 2008, as the rapid deterioration in economic conditions led to dramatic cuts in official interest rates.

From the beginning of 2008 to 24 December, the European Central refinancing rate fell from 4.25% to 2.50%, the U.S. Fed Funds rate fell from 4.25% to a target band of 0%-0.25% and the UK base rate fell from 5.5% to 2%.

For the ETFs in the table, the longer-maturity funds provided the highest price return, benefiting from the increased sensitivity to interest rates of long-dated bonds. The EasyETF iBoxx Liquid Sovereigns Global, Lyxor ETF EuroMTS 15+ Year, db x-trackers iBoxx Euro Sov. Eurozone 25+, and iShares $ Treasury Bond 7-10 ETFs all gave double-digit price returns (more if interest income were to be included).

At the same time, the yields on offer from these government bonds are now much less attractive to investors. The iShares short-maturity (1-3 year) Treasury ETF now yields a mere 0.66%, and only one of the other funds in the table yields over 4%. Even if yields stay low, it will be difficult, if not mathematically impossible, for these ETFs to repeat their 2008 performance in 2009.

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