FIXED INCOME DERIVATIVE REPLACEMENT

Case studies are for illustrative purposes only; they are not meant as a guarantee of any future results or experience, and should not be interpreted as advice or a recommendation.

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

THE BUYER

Pension fund looks beyond CDS indices to stake position in FI ETF

THE BACKGROUND

The pension provider wanted to tactically allocate to EUR-denominated credit. Given the volatility seen in markets during February and March 2020, the investor was looking for a liquid instrument to enable them to trade tactically while gaining broad, diversified exposure in line with their benchmark.

THE CHALLENGE

In credit, investors frequently use CDS indices to express tactical short-term views – a decision historically driven by the perceived incremental liquidity benefits in CDS instruments compared to ETFs.

THE FIXED INCOME ETF APPROACH

Due to widening basis between cash bonds and CDS during the March selloff, ETFs looked attractive on a relative value basis. In addition, the investor was looking for an instrument that more closely matched their bond portfolio characteristics, in terms of sector and quality dispersion. The investor traded EUR 230 million in a Corporate bond ETFs.

ETF and derivative spreads send a signal for investors
Spread between iTraxx Europe and IEAC I-spread (bps)

ETF and derivative spreads send a signal for investors

Source: BlackRock, Bloomberg (as of 30 May 2020). iShares corporate bond UCITS ETF index is the Bloomberg Barclays Euro Corporate Bond Index.

IEAC is chosen as the index because it tracks a broad index which is representative of the Euro corporate cash bond market. iTraxx Europe is chosen because this is the equivalent Credit Default Swap index covering Euro corporates. The purpose of the graph is to show how the two indices differ (this is what the “basis” is showing) to illustrate how cash bond indices differ to credit default swap indices.

Relative quality weights (%) in Bloomberg Barclays Euro Corporate Bond Index vs MAIN

Relative quality weights (%) in Bloomberg Barclays Euro Corporate Bond Index vs MAIN

Source: BlackRock, Bloomberg (as of 30 May 2020). iShares corporate bond UCITS ETF index is the Bloomberg Barclays Euro Corporate Bond Index.

Relative sector weights (%) in Bloomberg Barclays Euro Corporate Bond Index vs iTraxx Europe

Relative quality weights (%) in Bloomberg Barclays Euro Corporate Bond Index vs iTraxx Europe

Source: BlackRock, Bloomberg (as of 30 May 2020). iShares corporate bond UCITS ETF index is the Bloomberg Barclays Euro Corporate Bond Index.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of 13 October 2020 and may change as subsequent conditions vary.

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