* AUM reflects approx. $34.06 billion (as of 30 June 2017) with respect to which State Street Global Advisors Funds Distributors, LLC (SSGA FD) serves as marketing agent; SSGA FD and State Street Global Advisors are affiliated.
State Street Global Advisors’ Antoine Lesne on the evolution of the group’s SPDR ETF range, and why the fixed income ETF sector continues to attract investor interest during central bank policy normalisation
WELCOME
State Street Global Advisors is the third largest asset manager globally with $2.61trn* in assets under management. The group has more than 39 years of managing index exposures under the SSGA name. Antoine Lesne, Head of SPDR ETF Strategy & Research at SSGA, reveals why the size and heritage of group’s SPDR ETF range is helping it move ahead of its peers and how its fixed income offering can help investors navigate today’s low yield environment. In addition, Stephen Yeats, Managing Director, APAC & EMEA Fixed Income Beta Solutions, explores the rise of fixed income ETFs and why the group is applying a more targeted and hands-on approach to security selection in order to deliver investors’ desired exposures.
THE Q&A
The skill of our ETF portfolio managers is critical to tracking benchmarks accurately
Antoine Lesne,
Head of SPDR ETF Strategy & Research, State Street Global Advisors
Source: BIG (Fund View), SSGA as of 31 March 2017. Total Assets Under Management (AUM) is for Fixed Income assets managed by the Fixed Income Beta Solutions team only, exclusive of all cash and securities lending assets and fixed income portfolios managed by ISG. All calculations are unaudited. Other includes: indexing accounts with large degrees of customization, Convertible, Securitized and Municipal Indexing Strategies.
*Source: Morningstar Direct
What is behind the marked increase in ETF popularity in recent years?
ETFs are now used by an increasingly broad range of investor types – from wealth managers and private banks, to asset managers, pension funds and insurers, as well as robo-advisers, IFAs and individual investors. Part of their appeal is they can be used in a variety of ways: as the foundation of a portfolio, or to implement more tactical and sometimes very specific ideas. In addition, they are low cost, offer diversification within a single product (all ETFs track a diversified index), are transparent (investors can see the exact holdings on a daily basis), and there is a wide range to choose from. There has been a lot of speculation in the press about the growth of passive investments compared to the challenge active managers face in order to consistently beat benchmarks; particularly after costs are taken into consideration. Our view is that investors should consider both active and passive approaches: use an active approach where they can find managers who regularly provide alpha, and invest in ETFs or index funds where those active managers are harder to find or where the need is for a simple and transparent beta exposure.
What are the benefits of using fixed income ETFs in the current market?
It can be hard for investors wanting to build smaller, diversified portfolios to find liquidity in certain parts of the bond market. Fixed income ETFs provide a transparent and simple way to buy a diversified basket of bonds for a low cost. When it comes to managing volatility and market movements, the ability to trade intra-day is a valuable feature for investors wanting to move quickly. Having the options to move from all maturity or longer maturity exposures to lower duration exposures can help navigate periods of higher volatility. The proliferation of offerings and exposures in the fixed income ETF universe allows investors to actively allocate through volatile times.
How are SPDR ETF strategies evolving for a low rate environment?
As the yield from fixed income instruments, in particular government bonds, has shrunk, we have observed a shift towards exposures like emerging market debt local currency and high yield. However, we have also seen investors looking for yield in the equity space, in particular through our ETFs that track Dividend Aristocrats indices from S&P. The strategies focus on dividend growth and stability, potentially allowing investors to derive an income stream. Focusing on the technical aspect of the income element, all of our fixed income ETFs distribute dividends twice a year, allowing investors to capture part of the coupons earned by the fund. Meanwhile, as the direction of rate changes have been more challenging to forecast - even if the bias may be for slightly higher yields post-quantitative easing - we have developed a suite of maturity bucket ETFs both in dollar and euro Treasury indexation as well as short and intermediate maturity exposure in investment grade dollar and euro corporate. Lastly, short-dated corporate bond exposures in sterling in the 0-5 year area have proven popular with British investors willing to manage the interest sensitivity of their bond portfolios.
What are the advantages of using SPDR ETF?
Secondly, within Europe, we have a very competitive fixed income offering, in terms of the breadth of funds on offer, coupled with the skill of the porfolio managers managing the funds. Thirdly, SPDR was the first ETF provider to offer a full range of sector-focused ETFs, allowing investors to gain exposure to sectors on a global, US or European basis. Finally, our Dividend Aristocrats range is one of the largest smart beta (ie, non-market-cap weighted) ranges in Europe. All of our funds are physically backed, which is welcomed as many investors are reluctant to use synthetic ETFs due to potential counterparty risk and their associated lack of transparency. Meanwhile, our ETFs’ long track records mean we can demonstrate how they have performed over multiple market cycles.
The skill of our portfolio managers that run ETFs is critical to tracking a benchmark accurately and consistently. This is an important consideration that is sometimes overlooked by some investors. Moreover, within Europe, SPDR is probably best known for four things. Firstly, the size and heritage of the US business, including our ETFs focused on the S&P 500 (we launched this as the first major ETF in 1993), gold, and other sector exposures which all remain market leaders in their respective areas.
Which ETF sectors have seen the most growth?
As the world’s third largest ETF provider, we have seen increased flow into the majority of our range, in Europe, Asia Pacific and the US. In particular, we have seen substantial volumes move into our fixed income ETFs: SPDR gathered the second largest volume of assets last year in Europe with $2.3bn in flows. Over the last couple of years, fixed income ETFs have represented the main growth area for the industry as a whole and in EMEA particularly. The ability of bond ETFs to provide liquidity and perform as expected through numerous periods of market turbulence (such as the global financial crisis, the problems with Third Avenue, and the US taper tantrum in 2013) has provided reassurance. We have seen billions of dollars move into fixed income ETFs as a result to represent almost $740bn as of end September 2017*.
Risk profiling
Bank of England
Tapering may be slightly further away in the UK. BoE governor Mark Carney’s announcement in 2016 to increase asset purchases, cut rates and start corporate bond buying had a positive impact on yields and credit spreads. This changed when gilts reacted to the potential consequences of Brexit in late 2016. From a macroeconomic standpoint, inflation has been rising steadily after the Brexit decision, but the year-on-year effects may gradually fade away. The uncertainty surrounding Brexit negotiation talks could potentially cloud the outlook. As a consequence, we do not foresee any immediate tapering but watch carefully the recent hawkishness of the MPC. For now, this should support sterling corporate exposure despite spreads being relatively tight in this market (around 125bps).
European Central Bank
The impact of the ECB’s actions to hold rates and asset purchases is set to run until the end of this year “or beyond, if necessary”, and this has been driving peripheral spreads down. With populist risk slightly more remote in the eurozone, peripheral sovereign bond spreads have fallen almost to pre-crisis levels. This leaves little room for outperformance from there. Without the support of the ECB purchases, peripheral spreads may rise again. This makes us more positive on investment grade corporate and high yield bonds rather than broad euro treasuries for two reasons: credit spreads have been more resilient over the past tapering periods, and the interest rate sensitivity of these exposures is lower than for broad euro treasury indices.
Federal Reserve
We expect the Fed to hike again in December 2017; however, 2018, we may only see a handful of hikes. While tapering will result in the removal of somesupport for the US Treasury market, we expect it to be fairly limited in the first months of non-reinvesting maturing bonds and coupons of US Treasuries, to the tune of $6bn per month. In the investment grade credit markets, investors continue to find positive excess returns. This source would be difficult to replace outside of high yield or emerging markets. Spreads are at the lower end of their long-term range, but fundamentals remain relatively robust — for now. The slow removal of monetary accommodation should have minimal impact on credit spreads, marking a continuation of what happened in the past quarters when Treasury yields increased but spreads remained tight. We favour US investment grade corporate bonds to generate potential returns.
MACRO ANALYSIS
ETFs and The New Normal(isation)
A detailed look at how SPDR’s comprehensive fixed income suite of physically replicated ETFs are able to offer investors choice and flexibility during central bank normalisation
Globally, central banks have embarked on unprecedented balance sheet expansions since 2009.As the economy has improved, the need to normalisehas seen the fourth wave of tapering in eight years. Fixed income assets have performed very differently during each tapering phase. Perhaps surprisingly, riskier exposures such convertible bonds, corporate credit (both investment grade and high yield) as well as emerging market local currency debt have generally performed well. For example, the three month rolling excess return from corporate bonds appears to have lasted until late in the reduction of asset purchase phases during and after key tapering phases (see chart). The sector’s positive three-month rolling excess return lasted almost 12 months out of 15 during the first tapering period of May 2009-September 2010, and nine months out of 14 in the third tapering period that lasted from November 2013-February 2015. The second tapering period, from May 2011-September 2011, when global purchases fell from $100bn per month to circa $40bn (ending of the Federal Reserve’s QE2 purchases and a slowdown in the Bank of Japan’s treasury bond purchases as it faced a shortage of supply) is the only one that saw a notable underperformance of investment grade corporate bonds. This was due to tapering occurring during aperiod of stress in the eurozone, accompanied by a policy mistake in July 2011. In the current period of tapering, the sector has continued its positive excess return pattern.
THE INTERVIEW
Targeted bond ETFs designed to align with what investors require
Stephen Yeats,
Managing Director, APAC & EMEA Fixed Income Beta Solutions, SSGA
*Source: IHS Markit. As at 23 May 2017
Bond outlook
In a low yielding environment, concerns remain particularly in regards to how long the ‘bull run’ in bonds will continue. However, Yeats argues money is flowing into fixed income for a variety of reasons, many of which are less yield sensitive or dependant. “Investors may have liabilities or require diversification in a portfolio and therefore choose to invest in bonds. Sectors such as high yield and emerging market debt are also working well as part of growth portfolios.” Moreover, in more challenging periods for fixed income, a provider’s track record becomes essential to success. Yeats alludes to SSGA’s three-decade long history as a fixed income index solutions provider and argues: “We have the expertise to continue delivering bond solutions for a range of markets.” The fact that the group’s fixed income ETFs are supported by a physical replication model is further proof of its expertise. SSGA is one of only a few groups in Europe to offer physically replicated ETFs, namely due to the resource needed to implement it. “To do physical replication well, it is essential to have a large asset management operation and we have a team of over 30 portfolio managers spread across the globe working on our indexed fixed income portfolios alone,” says Yeats. “Our scale gives us more resource and we have built that infrastructure and the technology into the business.” “Having a dedicated sector team means for example that our emerging market debt team understands properly what trades well and what doesn’t, how much it should cost and or how much it should not. This is particularly important when looking at an ETF that tracks an index with hundreds or thousands of bonds and where there is a more meaningful trade-off between the optimal number of bonds to purchase, versus the tracking error risk and transaction costs.”
The growth of the exchange traded funds (ETF) industry saw assets swell to a record $4trn globally in 2016, driven in large part by fixed income-focused ETFs. Strong growth in fixed income ETFs saw the sector outpace every product category across the three main regions of America, Asia Pacific and Europe in the past 24 months alone*. As the range of fixed income ETFs on offer continues to grow, with investors seeking both greater choice and liquidity, State Street Global Advisers (SSGA) believes the key to success within this sector lies in providing a comprehensive suite of physically backed fixed income ETFs, thoughtfully constructed by a firm with over 30 years of history in fixed income index investing. This is one way the group’s extensive range of ETFs, distributed under the SPDR ETF name, offers a unique point of difference. With over $330bn of assets invested in indexed fixed income, SSGA’s fixed income ETFs are spread across the spectrum of risk, diversification and yield. However, the ETF range has been specifically designed by the group so that bond exposures are precisely aligned with what investors require for their investment strategy and the market environment today. Historically, some exposures like emerging market debt and global convertibles have only been available via active management.
This type of investment can provide a much more targeted exposure and allows investors to customise the portfolio’s credit or interest rate risk, or simply helps them better manage the underlying bond exposures, which often vary greatly across sectors, duration and maturity. “There are a lot of options when investing in bonds, in terms of duration, regions, credit risk, high yield, and emerging market debt too,” Yeats explains. “But we do not believe we need to buy every bond exposure in an index to get the same risk as the index.” This targeted approach has never been more important says Yeats, particularly as dedicating an active approach to bonds in today’s low yielding environment is a challenge due to the resources of fund selectors. “Managers have a limited amount of resource and the question is where is that resource best placed? It may well be that clients want their fund selectors to focus on those areas of the market and managers where the potential for alpha is higher, and that will have the most benefit in terms of meeting their investment objective; higher conviction active strategies, unlisted assets or alternatives, for example. “If you are able to use properly targeted and effective ETFs in your core allocations like fixed income, it leaves you with more resource and time to focus on other meaningful areas that are important to delivering the fund’s outcome, like asset allocation and picking good high conviction active managers to sit alongside an ETF based core.”
Targeted exposures
Stephen Yeats, managing director, fixed income beta solutions APAC and EMEA at SSGA, explains: “When we designed our fixed income ETF range we took what were very institutional quality indices; established and broad based containing lots of countries, currencies, credits and sovereigns. As a range they capture thousands of bonds and the underlying market cap is in the trillions of dollars. “But we design our ETFs to be more focused than that. This is achieved by breaking up the index into what we consider to be the main trade-offs that investors want. For example, a broad index can be broken down regionally, euro or US aggregate for example. We break that exposure up further by looking at corporates versus sovereigns. We can then break it up again by maturity buckets.”
Yearly historical flows (RHS $bns) and AUM (LHS $bns) into fixed income ETFs
Source: Morningstar Direct. As at 30 June 2017.
CONTACT US
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