2014 has been an interesting and turbulent year for the bond market. It has also been marked by the launches of a few groundbreaking income ETFs that provide investors more access to different pockets of the bond market than ever before.
China, in particular, figures highly—and rightly so. The world’s No. 2 economy after the U.S. is slowly opening up to foreign investors, and the ETF market is reflecting the best and latest ideas in the world of bonds that are now available.
With that in mind, here is my “Top 5” countdown of the most groundbreaking bond ETFs of 2014.
Credit Default Swap ETFs
While credit default swap (CDS) ETFs are nothing new in Europe, ProShares this year brought to market the first pair of U.S.-listed CDS ETFs. They are
WYDE and TYTE are “quasi-actively managed” ETFs. Their prospectuses say they are actively managed, but rather than picking individual CDSs, TYTE and WYDE mainly hold high-yield CDX—an investable index of 100 most actively traded CDSs on high-yield debts.
TYTE and WYDE provide investors tools, in an ETF wrapper, to express their views on the North American high-yield credit market without taking on duration risk.
- TYTE is a bet on an improving credit market that leads to CDS spreads tightening.
- WYDE is the exact opposite. It allows investors to express a bearish view on the credit market, deteriorating credit condition and widening spreads. Investors can also use WYDE to directionally hedge their high-yield exposure. However, since CDX indexes only track 100 equally weighted CDSs, it will always be an imprecise hedge for any market-value-weighted high-yield ETF.
Nov. 10 this year was a bond-trading holiday in the U.S., but something groundbreaking quietly happened that day in the world of bond ETFs. Market Vectors launched the first-ever U.S.-listed renminbi qualified foreign institutional investors (RQFII) China onshore bond ETF.
Using ChinaAMC’s RQFII quota, CBON holds a broad assortment of investment-grade exchange-traded bonds issued by the Chinese government, quasi-sovereign entities and private corporations.
Due to the segmentation of China’s bond market, I did express my concerns on CBON’s ability to track its underlying index in my previous blog. However, I have to give Market Vectors credit in overcoming regulatory and logistical hurdles to bring to market the very first RQFII China bond ETF. CBON also serves an important role in covering the broad bond market (government and private corporate) in China.
I just hope that CBON can improve on its execution with access to the interbank bond market. Institutions don’t seem to share my concern about CBON’s inability to access China’s interbank market, and rewarded the fund with more than $17 million seed capital.
Working with GF International Investment Management, Global X brought to market another broad-maturity China bond fund. CHNB places heavy emphasis on credit quality. It forgoes private corporate bonds and only holds bonds rated AAA issued by the Chinese government or entities explicitly or implicitly backed by the Chinese government.
While CHNB lost its bragging right of being the first-ever U.S.-listed RQFII bond ETF to CBON by less than a week, CHNB is the first China bond fund that has access to China’s interbank bond market. China’s interbank market is a restricted market wherein more than 90 percent of total bond trading activities occurs but only opens to selected authorized participants.
Many bonds, especially sovereign and quasi-sovereign bonds, are only traded in the interbank market. As such, access to the interbank market, in my view, is absolutely vital in providing comprehensive coverage of China’s debt market.
Seeded with more than $25 million and another large inflow in the following week, CHNB also seems to enjoy strong institutional backing.
KCNY, in my view, is the most groundbreaking fixed-income ETF of 2014. It is groundbreaking in two ways. It not only provides access to China’s debt market, it is also the first-ever commercial paper ETF, period.
Working with E Fund, an RQFII quota holder and interbank bond market participant, KraneShares provides investors access to the ultra-short-term part of China’s debt market. KCNY holds investment-grade commercial paper, debts with maturities of one year or less. These are the very same securities traded by money market mutual funds in China.
The thesis is simple: Deliver a money market mutual fundlike ETF that captures the impressive yields in China with very low duration. Seeded with more than $20 million, the fund seems to have solid institutional support too. If KCNY can deliver on its mandate, it might even be worth a discussion as the most groundbreaking ETF of 2014.
Trade any newly launched funds with caution and care. It will take some time for investors to understand and embrace new strategies, especially some groundbreaking products and access to uncharted territories.
Even though CDS ETFs have been around in Europe for some time, U.S. investors have yet to catch on. TYTE and WYDE’s asset flows and trading activities have been anemic. For institutions, accessing CDX directly might offer greater liquidity.
Despite solid institutional backing and large seed capital, none of the China bond funds is exactly lighting up the tapes. Not only it will take time for U.S. investors to understand the strategies, it will take more time for U.S. investors to feel comfortable with the credit and liquidity risk in a largely closed-off China debt market.
At the time this article was written, the author held a long position in KCNY. Contact Howard Lee at [email protected].