Barclays takes Europe’s financial pulse with new 'fiscal strength' covered bond indexes.
Barclays Capital, the company behind the iPath family of ETNs, has expanded its family of fiscal-strength-weighted indexes, launched in July 2011, to include covered bonds, which should address investor concerns about the increasing geographical concentration of the covered-bond industry in financially fragile eurozone countries.
Covered bonds are generally backed by pools of assets usually consisting of mortgages or public sector loans and have become an increasingly popular source of low-cost funding and liquidity for banks in the eurozone, which have been aided in this respect by the European Central Bank covered bond purchase program.
While they generally are viewed as safe investments because they are backed-up assets, many investors may not have the stomach to go after the underlying pool if the issuing institution goes into default. Thus the new Barclays indexes are meant to appeal to investors who want more protection. They are designed in the same spirit of the times that the new sovereign debt bond indexes Rob Arnott’s firm launched with Citigroup this week. The Citi-RAFI indexes minimize exposure to “aging and debt-laden economies.”
“In the covered bond space, market value weighted indices tend to be rather strongly exposed to Spain and France due to the high historical covered bond issuance activity out of these countries,” said Fritz Engelhard, head of Covered Bond Strategy at Barclays Capital, in a press release.
“Performance swings in these covered bond markets, given the sovereign crisis, exceeded the risk appetite of typical covered bond investors, and the new Fiscal Strength Weighted alternative achieves a reduction in index weights of the two countries,” Engelhard said.
The new Barclays benchmark indexes use measures of fiscal sustainability to adjust country weights within covered-bond benchmarks as opposed to existing market-weighted indexes the company already offers, which allocate about 40 percent of assets to Europe.
Covered bonds also have certain attractions for investors because, in contrast to the securitized mortgages, covered bonds are generally held in a collateral pool that remains on the balance sheet of an institution. That gives the investor recourse to the pool in the event of a default by the issuing bank. However, although investors have preferential claims, the actual protections depend upon the underlying jurisdiction that the bonds were issued under.
The three new indexes Barclays is launching are:
- Global Fiscal Strength Weighted Covered Bond Index
- Pan Euro Fiscal Strength Weighted Covered Bond Index
- Euro Fiscal Strength Weighted Covered Bond Index
All three of new indexes are alternatives to the Barclays Global Covered Bond Index that was launched in 2000 and tracks fixed-rate investment-grade covered bonds from 22 countries denominated in 11 currencies.
The three new indexes impose an overlay of ratings by credit agencies, debt-to-GDP ratios and deficit-to-GDP ratios to re-weight the countries contained within the Global Covered Bond Index based upon their fiscal health.
For the Global Fiscal Strength Weighted Covered Bond Index, on average, the Nordic countries have the highest overall fiscal strength scores, whereas the United States, Ireland and Italy have the lowest overall scores. The country that had the biggest adjustment from market value weights was France, which had an underweight of -7.52 percent due to its low country score combined with its large market cap.
The Pan Euro Fiscal Strength Weighted Covered Bond Index is 95 percent of the Global Covered Bond Index by market value, with the main difference being Canada, which has two-thirds of its issuance excluded because it is denominated in dollars. In the index, the Nordic countries again have the highest overall fiscal strength scores, whereas the United States, Ireland and Italy have the lowest overall scores.
The Euro Covered Bond Index comprises 80 percent of the Pan-Euro Covered Bond Index by market value and excludes much of the Nordic and Swiss currency exposure. The change creates significant market value weight differences. In this index, the weights of the eurozone countries were significantly readjusted based upon their debts and their deficits. The biggest readjustment was again France, which is underweighted by 7.48 percent.