Fixed income ETF specialist Tabula Investment Management warned investors about the dual threat of declining liquidity at the end of the year in bond markets and rising inflation in the United States.
Tabula warns bond markets often see weaker liquidity as the year draws to a close, with the short side gearing up to shrink balance sheets and the long side closing its books; however, the current uncertainty means that liquidity could turn out worse than in previous years.
Michael John Lytle, CEO of Tabula, said: “The current set of negative factors means the markets could experience more than just a seasonal drop in liquidity this year. As European lockdowns ease, there is a risk of a third wave of cases in the middle of winter. President Trump’s resistance to the election outcome also remains a wild card and expectations of deteriorating economic data are starting to rise. All of these have the potential to temper the recent vaccine-led relief rally.
Tabula offers its ETF Tabula iTraxx IG Bond UCITS as a potential solution for investors who share these concerns. ETF is based on IBoxx iTraxx Europe Bond Index and places a strong emphasis on liquidity.
The index provides exposure to European corporate bonds that closely reflects the geographic and sector exposures of the iTraxx Europe, a widely followed benchmark index measuring the performance of a long credit position in credit default swaps on 125 high quality European issuers.
The index selects up to three bonds for each issuer in the current iTraxx Europe series that have a minimum outstanding amount of EUR 500 million and a remaining term to maturity of 3 to 7 years (extended to 1 to 10 years if an issuer has no bonds in the 3 to 7 year range).
The index is constructed with fixed sector weighting brackets. Core weights are Automotive & Industrials (24%), Consumers (20%), Energy (16%), TMT (16%), and Financials (24%) – these are categories of supersectors made up of several conventional sectors and industries. With the exception of the financial sector, which is fixed, sector weights can deviate by up to 20% on either side of their base weight.
The index assigns an equal notional weighting to each issuer and targets an average maturity of around 5 years. The index is reviewed in March and September in accordance with iTraxx Europe.
To be eligible for the iTraxx Europe – effectively the index selection pool – a bond must have a fixed coupon, be denominated in euros and issued by an entity domiciled in Europe, and have an investment grade rating.
The ETF is tradable in euros on the London Stock Exchange (TTRX LN), Xetra (TABX GY), and Borsa Italiana (TTRX IM). It has an expense ratio of 0.29% and has € 110 million in assets under management.
On inflation, Tabula notes that the fiscal stimulus under the new Biden administration is expected to further increase the upward pressure on prices, while the Federal Reserve has pledged to adopt a new regime that will allow inflation to exceed. its historic target of 2%.
According to Tabula, President-elect Biden will likely back the Fed’s accommodative policies with his choice for Treasury Secretary, former Fed Chairman Janet Yellen, suggesting a close connection between fiscal and monetary authorities.
Tabula cautions that these factors, combined with the demand / supply fallout from Covid-19, indicate that inflation is once again firmly on the agenda and is likely to be a growing concern among institutional investors.
Lytle said: “This year we have witnessed an extraordinary monetary stimulus which, combined with loose monetary policy, gives a boost to future inflation. The Federal Reserve’s balance sheet has doubled in six months, and the global narrow and broad money supply has grown 22% and 14% respectively this year – the annual growth rates last seen in 1993 and 2008 respectively.
“Changing central bank mandates and new fiscal policies are also putting pressure on inflation. The incoming Biden administration has pledged to continue the stimulus measures related to Covid-19, including more direct payments to households. This, combined with what the Fed does next, could significantly affect the outlook for inflation in the United States. “
Tabula’s most recent list, launched last month, could offer a compelling solution to dealing with this inflationary environment. the ETF Tabula US Enhanced Inflation UCITS provides exposure to realized and expected inflation by tracking Bloomberg Barclays US Improved Inflation Index, a new index developed by Bloomberg in partnership with Tabula.
The index measures the performance of a diversified portfolio of US Treasury Inflation-Protected Securities (TIPS) combined with exposure to US inflation expectations over the medium term. Both sleeves are 100% weighted.
The TIPS portfolio consists of securities with a par value of at least $ 500 million outstanding and at least one year remaining to maturity. TIPS differ from regular treasury bills in that the principal amount of a TIPS issue is adjusted over time to reflect changes in the underlying consumer price index, a measure of inflation. The return on TIPS therefore reflects a real interest rate where the effect of inflation has been largely eliminated.
The index’s exposure to inflation expectations is represented by a long position in 7-10 year TIPS and a short position in traditional 7-10 year Treasury bills to hedge the duration risk. An increase in inflation expectations over 7-10 years will result in a net appreciation in value, as rising inflation expectations will cause the yields of common treasures to rise and their prices to fall, thus providing a positive performance for the short component of the transaction. The short position is adjusted to offset the duration exposures of the two indices, thus establishing a purer play on inflation expectations.
The ETF has an expense ratio of 0.29% for an unhedged USD share class on LSE (TINF LN) and 0.34% for the GBP hedge (TING LN) and hedged in EUR (TINE IM) share classes on LSE and Borsa Italiana respectively.