Introductory Guide to Developed Market Bond ETF Investing - ETF News And Commentary


Recent developments in the domestic, as well as global, markets have resulted in heightened volatility across all asset classes. The stock markets across the developed world got off to a choppy start in 2014 with little signs of full-fledged recovery.

While the U.S. market started returning to life, the growth scenario still appears shaky in other parts of the developed market including Europe, Australia, Canada and Japan. Central banks kept key interest rates at a considerably low level with the European Central Bank (ECB) establishing a negative interest rate in early June. Promoting growth and moderate inflation remains the main agenda of these central banks (read: 3 European ETFs to Buy After ECB Action ).

Extremely accommodative monetary policies in most developed nations shifted investor preferences toward a regular source of current income. Added to these, geo-political tensions from Russia to Iraq to Gaza have taken the center stage this year leading investors to flee from the risky asset classes and seek solace in the so-called safe haven bond segment.

Yields Remain Low across the Board

Thanks to higher demand for bonds, yields in developed market plummeted considerably this year. Per Bloomberg , 10-year yields are hovering around 2014's lowest levels in 21 of 25 developed markets. As of July 23, 2014, Euro area yield for 10-year bonds came in at 1.295% , down from 1.842% noticed on the same day last year and 3.256% three years ago.

Within the Euro zone, German bonds are considered one of the safest bets. German 10-year bond yields slipped to 1.14% in July from 1.25% in June 2014, as per trading economics . On July 29, German 10-year yields touched the low of 1.109%, exceeding the prior low seen in 2012. Italy and France witnessed a respective of 14 and 15 bps plunge in sequential change in yields. Yields in Italy touched an all-time low level of 2.71% in July while 1.70% yield in France was slightly higher than the all-time low level.

Trading economics also noted that Australia's 10-year government bond yield fell to 3.45% in July from 3.56% from the prior month. The yield on 10-year Japan government bond declined to 0.53% in July from 0.57% in June of 2014 while the same in Canada fell 7 bps from last month to 2.17% in July. Though the U.S. market started noticing an ascent in long-term yield from July as the stocks started rallying, yields on 10-year bonds were 2 bps lower at 2.50% in July 2014.

Notably, bond yields and bond prices have an inverse relationship. Thus, a slump in the developed market bond yields led to a rally in bond ETFs. Amid such a situation, we highlight the three main choices that investors may find suitable bets in this space:

PowerShares DB Italian Treasury Bond ETN ( ITLY )

The product tracks the performance of a long position in Euro-BTP Futures. The assets of Euro-BTP Futures are Republic of Italy-government issues debt securities with an original term of no longer than 16 years and a remaining term to maturity of not less than 8 years and 6 months and not more than 11 years as of the futures contract delivery date. 

The product charges an expense ratio of 50 bps a year. The product has returned about 13.25% so far this year (as of July 25, 2014) (read: Guide to European Bond ETF Investing ).

 Australia Bond Index Fund ( AUD )

This fund is the only U.S. ETF that aims to provide focused exposure to the Australian dollar-denominated, investment grade bond market.  The fund looks to track the BofA Merrill Lynch Diversified Australia Bond Index (read: Australia Bond ETF Showdown: AUNZ vs. AUD ).

The 40-holding ETF targets the intermediate part of the yield curve with an effective maturity of 4.99 years. This makes AUD relatively more stable than its long-term counterparts in terms of interest rate risk as indicated by an effective duration of 4.23 years.

AUD charges an expense ratio of 0.45% while it has returned about 11.02% in the year-to-date frame (as of July 25, 2014).

DB German Bund Futures ETN ( BUNL )

BUNL provides investors with exposure to the U.S. dollar value of the returns of a German bond futures index. It based on the DB USD Bund Futures Index which is intended to measure the performance of a long position in Euro-Bund Futures. BUNL charges an expense ratio of 0.50%. BUNL has gained about 8.54% in the year-to-date frame (as of July 25, 2014).

Other Choices

Not only the above-mentioned exchange-traded products, bond ETFs on Canada and the U.S. also warrant a look. However, in the U.S., long-term bond ETFs are performing better than the short-term ETFs this year given the prospect of a hike in interest rates next year.

So, investors interested in making a play in the U.S. bond markets should tap products like 20+ Year Treasury Bond ETF ( TLT ), 1-30 Treasury Ladder Portfolio ( PLW ) and iShares 7-10 Year Treasury Bond ETF ( IEF ). The trio has returned about 15%, 8.65% and 5.63% this year respectively (read: Long-Term Treasury Bond ETF Investing 101 ).

On the Canadian front, Canada Bond Index Exchange-Traded Fund ( CAD ) will be a suitable bet . CAD was up about 5% this year. There is yet another Euro bond ETF - Euro Debt Fund ( EU ) - which saw a rise of 5.1% so far this year.

However, one word of caution is that most international bond ETFs carry exchange rate risk as the ETFs hold securities issued in different currencies. Moreover, if the U.S. Dollar appreciates further against other major currencies, the value of the investments will go down even if the investment has generated positive sub-par returns. Therefore, investing in this foreign currency denominated assets necessarily involves having a bearish view of the U.S. Dollar (read: 3 Treasury Bond ETFs to Play Rising Short Term Yields ).

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PIMCO-CDA BIETF (CAD): ETF Research Reports

WISDMTR-EURO FD (EU): ETF Research Reports

PIMCO-AUS BIETF (AUD): ETF Research Reports

PWRSH-DB GBF (BUNL): ETF Research Reports

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , ETFs

Referenced Stocks: CAD , EU , AUD , BUNL

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