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Corporate bond investingAccess to a well-diversified selection of liquid corporate bonds
With the family of UBS ETFs, it is easy to access the corporate fixed income markets in the USA and Europe. The UBS corporate bond ETF tracks indices that reflect a well-diversified selection of bond issues which meet specific maturity and liquidity requirements. Credit quality is considered with a focused UBS investment grade bond ETF or high yield bond ETF.
Characteristics of UBS bond index funds
UBS bond index funds look at specific segments of the corporate-bond market with a regional focus or currency-specific bonds, specifically short-end or full maturity. Additionally, UBS bond ETF are available in a number of trading currencies as well as currency-hedged share classes. You can add the fixed income exposure the way you want, choosing the best bond ETF for your investment portfolio.
The UBS corporate bond index funds provide investors with benchmark exposure to the most important corporate fixed income markets in USA and Europe.
With UBS corporate bond ETFs, investors can build their portfolios by adding regionally-orientated or currency-orientated fixed income investments. The corporate credit segment is an attractive addition to the equities and sovereign credit which typically sit in multi-asset portfolios. The investment objective of the these ETFs is to replicate the price and accrued interest performance of the corporate bonds indices.
Your benefits of investing in corporate bonds UBS ETFs at a glance:
- Provide investors with benchmark exposure to the most important corporate fixed income markets in USA and Europe
- Well diversified investments due of selected bond issues which meet specific maturity, credit quality and liquidity requirements
- Exposure to high quality corporate issuers with investment-grade ratings
- Modular regional structure and diversification through exposure to corporates operating in a variety of economic sectors
- Local currency and currency hedged investments provide flexibility to match underlying fixed income exposure with funding currency, or to take a directional bet on currency movement
- Physical index replication means no counterparty risk from swap transactions
- Bonds are generally considered safer than equities because if an issuer defaults it must pay its bondholders before it pays its shareholders, but the level of risk depends on the type of bond. For example, holding corporate bonds will deliver higher returns than holding government bonds, but they associate with a greater risk reflecting an increased risk of payment due to a corporate default. In general, all bonds are subject to interest rate risk, liquidity risk, inflation risk, default risk, and rating downgrades.
Modern portfolios comprise of equity and fixed income investments, and possibly other assets like commodities, real estate or alternatives. In a multi-asset portfolio, fixed-income exposure has the potential to reduce the overall risk through high preservation of capital with a guaranteed income stream through regular projectable coupon payments. Figure 1 shows the long-term performance in net total returns of the broad fixed income market compared to the broad equity market dating back to 1973 for the US market.
Source: Barclays, Bloomberg. Past performance of investments is not necessarily a reliable indicator of future results.
Figure 1: Performance in net total returns (monthly data Jan 1973 – Jan 2015, USD) US Government 10 year yield (rhs)
The equity returns experienced more volatility and swings in performance, whilst fixed income investment (both corporate and sovereign) delivered lower return associated with substantially lower volatility. In recent years, corporate bonds outperformed safer treasuries resulting from the search for incremental yield pickup in liquid high quality corporate bonds for example.
Importantly, in the years when the equity market was experiencing severe drawdowns, the fixed income investment was typically offsetting losses by delivering positive return (or facing substantially lower losses than equity markets like in 2008) proving its importance for more balanced portfolios.
The historically good performance of fixed income investments can be associated with the decreasing inflationary pressure and lower interest rates, as seen in Figure 1. Of course, with interest rates going down, the price of the issued bond goes up, all else being equal, implying capital gains for the portfolio. In this example however, if the Federal Open Market Committee (responsible for US monetary policy) would seek to tighten monetary policy, there would be a downward price-correction on the issued bonds, offset by coupon income to a certain degree.
Bond ETFs track major fixed income indices by holding issues in the underlying universe as defined by index provider. Investible bond indices represent segments of the fixed income market, be it Treasury securities, corporate bonds, or municipal bonds, and may focus on a certain part of the yield curve (e.g. short duration).
In the corporate segment, the standard classification separates issuers rated with an investment grade from the non-investment grade. Another classification deals with the currency of the issued bond or risk domicile of the issuer. Table 2 summarizes major inclusion criteria of the corporate bond indices tracked with UBS ETFs.
Inclusion criteria | Barclays US Liquid Corporate | Barclays Euro Area Liquid Corporate |
|---|---|---|
Currency | Principal and coupon must be denominated in USD | Principal and coupon must be denominated in EUR |
Domicile | Issuer country of risk must be US | Issuer country of risk must be Eurozone member state |
Eligible Issuer Type | Corporate | Corporate |
Amount Outstanding | USD 1bn minimum par amount outstanding | EUR 500mn minimum par amount outstanding |
Credit Quality | Securities must be rated investment grade | Securities must be rated investment grade |
Terms of Maturity | At least one year until final maturity regardless of optionality (1+) | Remaining time to maturity of one to five years (1-5) |
Seasoning | Time since issuance (dated date) less than two years | Time since issuance (dated date) less than two years |
Minimum Piece / Increment | Minimum piece no greater than USD 50'000 / Minimum increment no greater than USD 1'000 | Minimum piece no greater than EUR 100'000. |
Coupon | Fixed-rate coupon; also callable | Fixed-rate coupon; also callable |
Seniority of debt | Senior and subordinated issues are included | Senior and subordinated issues are included |
Rebalancing | Monthly | Monthly |
Currency Hedged Indices | Available | Available |
Inclusion criteria | Markit iBoxx EUR Liquid Corporates | SBI Foreign |
|---|---|---|
Currency | Principal and coupon must be denominated in EUR | Principal and coupon must be denominated in CHF |
Domicile | All | All excl. Switzerland and Lichtenstein |
Eligible Issuer Type | Corporate | Corporate, Sovereign and Supranational Agencies |
Amount Outstanding | EUR 750mn minimum par amount outstanding | CHF 400mn minimum par amount outstanding |
Credit Quality | Securities must be rated investment grade | Securities must be rated investment grade |
Terms of Maturity | At least one year until final maturity regardless of optionality (1+) | Remaining time to maturity of one to five years (1-5) |
Seasoning | Time since issuance (dated date) less than three years | NA |
Minimum Piece / Increment | NA | NA |
Coupon | Fixed-rate coupon; callable are excluded | Fixed-rate coupon; also callable |
Seniority of debt | Senior and subordinated issues are included | Senior and subordinated issues are included |
Rebalancing | Quarterly | Monthly |
Currency Hedged Indices | NA | NA |
Table 1: Index Inclusion Criteria
Given distinct inclusion criteria, investors have the possibility to pick their preferred exposure. For example, Barclays Euro Area Liquid Corporate 1-5 Years Index comprises of EUR-denominated bonds with maturities of between 1-5 years issued by Eurozone-domiciled corporates. By contrast, the Markit iBoxx EUR Liquid Corporates comprises of EUR-denominated bonds regardless of the issuer domicile or bond maturity.
Within the index, it is the terms of maturity which define sub-segments. For example, the SBI Foreign tracked indices have two maturity baskets, 1-5 years and 5-10 years that provide investors with flexibility to invest in the part of the yield curve within their interest rate risk requirement. Note, also that this index blends issuer types, i.e. corporates as well as (sub-) sovereigns.
Importantly, the inclusion criteria defining credit quality states that securities must be rated investment grade. Because the creditworthiness of an issuer is of major significance, index providers apply the ratings of the leading credit agencies Moody’s, S&P and Fitch to construct the composite (typically average or middle) ratings. In cases where explicit bond level ratings may not be available, other sources (e.g. local agencies, banks etc.) may be used to classify securities by credit quality.
Credit events associated with downgrades are continuously monitored at the bond level, and issues violating credit quality requirements can be removed from the universe.
Bonds are sold in the primary market directly from issuers and they can then be traded in the secondary market before their final maturity date. Qualifying securities issued in the primary market may be considered for inclusion in the benchmark index if required security reference information and pricing are readily available. However, the majority of bonds in the underlying index are traded on the secondary market, where liquidity is the key requirement for the physical replication of the index. Generally speaking, low liquidity negatively impacts the ETF Net Asset Value performance through higher trading and rebalancing costs.
In addition, if eligible bonds for the selected benchmark face low liquidity, they may not be included into the ETF holdings as a result of sampling, thus potentially leading to an increase in tracking error. At the macroeconomic level, higher liquidity is generally associated with good economic conditions thus implying lower default risk. Once economic conditions deteriorate - and default risk is perceived to be higher - liquidity issues may easily emerge. At the bond level, higher liquidity generally means that:
- Bonds with higher credit ratings are usually more liquid than low quality credit.
- Bonds with issuer risk domiciled in developed economies are usually more liquid than those of emerging economies.
- Bonds "on the run" (i.e. following issuance) are usually more liquid than those issued in the distant past.
- Bonds with a simpler structure (standard fixed-rate coupon) are usually more liquid than bonds featuring additional complexities or clauses (e.g. sinkable, perpetual etc.)
- Bonds denominated in major currencies (e.g. USD, EUR, CHF or GBP) are usually more liquid than bonds denominated in emerging-market currencies.
- Larger issue size usually helps to improve tradability on the secondary market.
The over the counter (OTC) nature of fixed income markets makes measuring liquidity risk considerably more challenging than in equity markets. For example, the liquidity of a ten-year bond is not the same as of six-months one even for the same issuer. One applicable liquidity measure is the Barclays' Liquidity Cost Scores (LCS) which is the cost – as a percent of the individual bond’s price – to execute a round‐trip transaction, i.e. the cost of immediately transforming the bond to cash, and vice versa. Individual scores can be aggregated up to the portfolio level; for example an LCS score of 1.5 would imply that an immediate round‐trip would currently cost 1.5% of the bond portfolio price. Figure 2 shows the LCS times series for four indices for illustrative purposes. It is clear that the most liquid index is the US Treasuries (LCS on right-hand-scale), showing that a round‐trip transaction would cost as little as 3 basis points (or 0.03%). By contrast, the US High Yield index is the least liquid one and in credit stressed times (e.g., beginning of 2009), the costs can turn as high as 7%. The UBS ETFs tracked indices meet the general requirements favouring liquidity, i.e. focus on investment grades, large issues "on the run" in developed markets and major currencies. As a result, the Barclays US Liquid Corporate Index experiences an average LCS of approx. 60 basis points (or 0.6%), as seen in Figure 2.
Source: Barclays POINT.
Figure 2: Liquidity Cost Score (in %)
Empirical studies focusing on currency risk suggest that investors bearing currency risk are not compensated with systematically higher returns, meaning it is not economically rational to carry this risk. This results from the fact that currency movements are mean-reverting to their economic equilibriums over time thus having both positive and negative impacts in time.
Figure 3 shows an example of the monthly returns from the Barclays US Liquid Corporate 1-5 Year Index (price and coupon returns) in local currency (USD) and in Figure 4 when the investment is funded in CHF without a currency hedge in place.
Source: Barclays POINT. Past performance of investments is not necessarily a reliable indicator of future results.
Figure 3: Monthly returns on Barclays US Liquid Corporates 1-5 Year Index (index currency USD and funding currency USD)
Source: Barclays POINT. Past performance of investments is not necessarily a reliable indicator of future results.
Figure 4: Monthly returns on Barclays US Liquid Corporates 1-5 Year Index (index currency USD funding currency CHF)
Figure 3 highlights two aspects as we move along the time, i.e. smaller changes in bond prices and also smaller coupon returns. This is in line with the US monetary policy of cutting the reference interest rate over that period.
It is insightful, however, to compare price and coupon returns in USD currency (shown in Figure 3) to the case when the funding currency is CHF, shown in Figure 4 which includes the impacts of currency movements. The magnitude of currency returns - both positive and negative movements - is absolutely dominant. And while currency movements may create some opportunities, they are undoubtedly associated with additional volatility.
For investors seeking fixed income return, the unhedged currency exposure may appear as too risky yet with most of the risk being attributable to the fund vs. funding currency mismatch. To mitigate currency risk and budget the risk more properly, UBS ETFs tracking Barclays corporate bond indices offer currency hedged share classes which provide undiluted exposure to corporate fixed income investment. The currency hedged indices assume a monthly frequency of resetting the hedge contracts.
Corporate bond investment products in focus
Markit indices
SBI indices
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