ProShares Launches Covered Bond ETF
May 23, 2012
ProShares, the world’s largest purveyor of leveraged and inverse exchange-traded funds, today rolled out a dollar-denominated covered bond ETF with holdings that are secured by the good faith and credit of their issuing institutions.
The new fund, the ProShares USD Covered Bond ETF (NYSEArca: COBO), comes with a net annual expense ratio of 0.35 percent, which includes a 0.43 percent fee waiver effective through Sept. 30, 2012.
COBO tracks the performance of dollar-denominated covered bonds, which are debt instruments issued by financial institutions that are secured by a pool of financial assets, typically mortgages or public sector loans.
Covered bonds have typically been considered a super-safe investment because, in addition to having a senior claim on the financial institution that issues them, bondholders have a senior claim against the covered pool of assets in the event of a default on the part of the financial institution.
Currently, the fund’s underlying BNP Paribas Diversified USD Covered Bond Index consists of 43 covered bonds issued by 20 different issuers, all of which are financial institutions.
The issuers are primarily Canadian and European. The weights representing the percentage of dollars invested per country are:
The covered bonds in the portfolio must be denominated in U.S. dollars, have a fixed-rate coupon, at least 18 months to maturity, $1 billion or more of outstanding face amount and a minimum denomination of $250,000.
However, as a recent filing detailing the ETF notes, mortgage-related or other asset-backed securities may be subject to greater volatility as a result of slight movements in interest rates.
Fund And Index Details
These types of assets also are subject to risk from the ongoing housing downturn. Further, as the prospectus notes, there is no guarantee that the covered pool will adequately fully compensate bond investors in the event that an issuer defaults.
To safeguard against asset deterioration, COBO's underlying index aims to include dollar-denominated fixed-rate covered bonds that have the highest ratings from Fitch Ratings, Moody’s Investor Services and Standard & Poor’s Rating Group’s rating categories. Any bond that's downgraded will be removed from the mix.
The ETF will invest at least 80 percent of its total assets in covered bonds, while the rest may be invested in other securities or derivatives that ProShares believes tracks the performance of the index, the filing said.
The fund uses a sampling strategy, meaning it won’t own all the securities in the index. Such sampling is typically associated with a greater tracking error than a strict replication strategy.
If a covered bond no longer satisfies the eligibility criteria, it will be removed from the index when the index is rebalanced. The index is rebalanced on the last business day of the following months: January, April, July and October.
The expected active-market trading of shares in this fund is intended to be attractive to arbitrageurs, as trading activity is critical to ensuring the market price of fund shares remains at or close to their net asset value.
However, the expected high frequency of trades may cause more frequent creation or redemption activities that could, in certain circumstances, increase the number of portfolio transactions.
High levels of transactions increase fund brokerage costs and may result in increased taxable capital gains, the fund prospectus noted.