Update: iShares Italy Government Bond UCITS ETF

As this fund offers exposure to the entire maturity spectrum of Italian sovereign debt it is therefore suitable for investors seeking a shield from potentially negative performance stemming from market shifts across the yield curve.

This ETF is suitable as a core building block for an Italian-centric portfolio, or as a satellite, yield-enhancing element for a wider EUR-denominated portfolio. It can also be used as a satellite component in non-EUR portfolios, though FX considerations would apply.

Fundamentale Analyse

In 2014, Italy registered a debt-to-GDP ratio of over 132%, the highest level recorded in the country. This has been fuelled by long-term increases in public spending, which climbed by over 18% between 2000 and 2010. In response, a series of biting austerity measures have been implemented, which while partly successful in curbing spending, also provoked social unrest and political uncertainty. The nomination of Matteo Renzi as PM in early 2014 was welcomed by markets on the expectation that he would bring much needed political stability and push through plans for significant economic reform. His record on the latter front remains underwhelming, while calls for reform have intensified as the Italian economy fell back into recession in 2014.

Despite its economic underperformance, Italian government bonds, like those issued by other Eurozone periphery members have performed remarkably well over the past couple of years. This can be largely attributed to ECB President Draghi’s pledge “to do whatever necessary to save the Euro” in the summer of 2012. Prior to that announcement, Italian sovereign yield spreads over the German bunds swelled to pre-Euro levels as the markets feared the break-up of the Eurozone.

More recently, in response to falling price levels and anaemic growth, the ECB has stepped up its accommodative policy stance, further supporting valuations. In January 2015 the bank announced a massive quantitative easing programme, which involves the buying of 60bn Euros of government bonds on a monthly basis until, at the earliest, September 2016. Full blown QE represents the latest, and most dramatic in a series of economic stimulus measures introduced by the ECB, including earlier asset buying initiatives (e.g. covered bonds) and successive interest rate cuts which have left lending rates hugging the zero bound.

In principle, QE provides strong support to Eurozone government bond valuations. However, with bond yields falling across the board and Italian spreads over German bunds shrivelling, investors may soon begin to question whether Italian bonds have reached fair value.

The firm expectation is for historically low interest rates to remain in place for a protracted period. That said, in the unlikely event that Eurozone price levels rise dramatically, the ECB, due to its mandate, would have to raise rates in response. If administered indelicately, this could prompt a stampede of investors exiting their fixed-income positions. Under these circumstances, this ETF may be subject to capital losses.

Indexkonstruktion

The Barclays Italy Treasury Bond Index measures the performance of the full maturity spectrum of Euro denominated debt issued by the Italian Government. The index rebalances on a calendar month basis and consists of fixed-rate government bonds with at least one year remaining until maturity and a minimum outstanding amount of EUR300m. The index has a weighted average maturity around eight years.

Fondskonstruktion

iShares uses physical replication to track the performance of the Barclays Italy Treasury Bond Index. iShares uses sampling techniques to achieve this return. Under this arrangement, iShares attempts to achieve the return, duration and geographical exposure of the index without necessarily holding all index constituents at the exact weights as the index. In practice, the securities held by the fund rarely stray too far from those dictated by the index. To help further improve tracking performance, the fund engages in securities lending. BlackRock has a 50% cap on the amount of assets that its iShares funds can lend out. In the 12 months through the end of December 2014, an average of 2.16% of the portfolio was out on loan. The lending programme added 0 basis points of net return to the fund. BlackRock, iShares’ parent company acts as lending agent, keeping 37.5% of gross securities lending revenue for itself, out of which amount it will pay the associated costs of the activity, and passing 62.5% of the revenue to the fund. To protect the fund from a borrower’s default, BlackRock takes collateral greater than the loan value. Collateral levels vary from 102.5% to 112% of the value of the securities on loan, depending on the assets provided by the borrower as collateral. Cash generated from coupon payments is held by the fund until distributions are made to fund unitholders on a semi-annual basis. This can create a cash drag on the portfolio, causing it to underperform its benchmark in rising markets and outperform in declining markets. Historically distributions have followed a June-December payment schedule.

Gebühren

iShares charges a total expense ratio (TER) of 0.20% for this ETF, which is average for funds offering broad Italian sovereign exposure. It should be remembered that there are additional, investor-specific costs associated with trading the ETF, such as bid/offer spreads and brokerage commissions, which should be factored into an investment decision. There are also rebalancing costs whenever the index changes composition.

Alternativen

Currently, the only other ETF offering broad exposure to the Italian debt market is offered by db X-trackers. This fund synthetically replicates the MTS Italy BTP Ex-Bank of Italy index which reflects the performance of bonds issued by the Italian government belonging to the BTP (Buono del Tesoro Poliennale) security type, which means that they pay a fixed rate of interest. The fund charges a TER of 0.20%.

Investors seeking longer-dated exposure may consider the Lyxor UCITS BTP 10Y - MTS Italy Government Bond ETF, which offers exposure to the 10-year maturity segment of the Italian sovereign debt market. The fund uses physical replication and charges a TER of 0.165%.