Update: iShares Swiss Domestic Government Bond 3-7

Dieser ETF auf Bundesobligationen konzentriert sich auf die mittleren Laufzeiten.    

Jose Garcia-Zarate 19.09.2014

Rolle im Portfolio

The iShares Swiss Domestic Government Bond 3-7 ETF offers investors exposure to the performance of the medium-dated segment one of the safest government bond markets in the world. For most investors, particularly non-Swiss based, this ETF is likely to be used as a hedge to riskier elements in an investment portfolio. The benefits of this insurance policy role could be ultimately defined as compounded, as capital gains on Swiss government bond holdings at times of risk aversion might be enhanced via currency strengthening, with the Swiss Franc (e.g. CHF) also fulfilling a safe-haven role in the world’s foreign exchange market.   

Despite the medium-dated maturity bias, investors may also consider this ETF for cash (e.g. CHF) equitisation purposes. However, attention should be given to the potential for capital losses arising from exposure to domestic interest rate risk. Regarding this latter point, those with a Swiss-centric portfolio can also use this ETF for duration management purposes in response to variations in interest rates, with the medium-dated maturity of the fund allowing for both lengthening and shortening strategies depending on the overall duration of the investment portfolio.

Unless used as the fixed income building bloc of a Swiss-centric investment portfolio, the majority of likely uses for this ETF would make it more a satellite than a core element in asset allocation. As this is a CHF-denominated non-UCITS-compliant ETF, non-Swiss investors will have to account for foreign exchange and specific tax implications whenever making use of it.

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Fundamentale Analyse

Switzerland is an international safe-haven of choice at times of crisis. This is predicated on a raft of factors, amongst which macroeconomic strength and sound public budget management. The federal government is constitutionally bound to keep a balanced budget over the economic cycle, and although it is allowed to run deficits at times of economic slowdown, budget shortfall projections rarely exceed 1.0% of GDP per annum. Swiss federal government bond issuance is not a common market event, while the commitment to budgetary stability keeps the overall public debt burden at comparatively low levels (e.g. 30-40% of GDP). 

Swiss government bonds have been met with a solid body of demand from 2008 onwards. Yields have collapsed and, despite the easing of tensions in the Eurozone debt market since H1 2012, do remain at historically low levels - even negative for short maturities.  

Safe-haven flows have also pushed the Swiss Franc (CHF) to levels the Swiss National Bank (SNB) saw as threatening export competitiveness and, more worryingly, with the potential to cause a sustained deflationary phase. As a result, since H2 2011 the SNB has kept interest rates at 0.0% while also targeting a maximum CHF/EUR 1.20 exchange rate, underpinned on a promise of intervention in international FX markets whenever required. These policy settings remain in place as we write (e.g. early September 2014). 

The strength of the CHF has been a key factor in keeping Swiss inflation at very low levels. In fact, the economy experienced a deflationary phase in 2012 and most of 2013. The SNB expects inflation to remain at very low levels (e.g. 0.0-0.3%) throughout 2014 and 2015.   

The Swiss economy has weathered the global crisis in much better shape than other developed economies, mainly owing to its exporting strength. However, the SNB sees increased downside risks into 2015, with the Eurozone’s flimsy recovery and the slowdown in emerging markets as key areas of concern. The SNB expects GDP to grow by 2.0% in 2014. 

Swiss monetary policy settings are likely to be kept on ultra-loose mode for a very protracted period. As a result, yields on Swiss short-to-medium-dated government bonds should be expected to remain at very low levels for the foreseeable future. Besides, since September 2013 the SNB requires all Swiss banks to provide higher capital backing for residential mortgage loans. This measure, designed to temper the odds of a housing market bubble developing in the country, is also seen as providing solid support to the Swiss government bond market.   

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The Swiss Bond Index Domestic Government 3-7 is a sub-index of the Swiss Bond Index Domestic Government. The index is calculated using bid prices from SIX Swiss Exchange and is published in real time as early as 08:30 am CET. It includes all CHF-denominated fixed-rate Swiss government bonds with remaining maturity between three and seven years and minimum outstanding of CHF 100mn. Each bond is weighted by its market capitalisation. The index is calculated both on a price and total return basis, with coupon payments reinvested overnight in the latter case. Changes to the index are made on a monthly basis on the first trading day of each month.

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The ETF was launched in November 2003 and is domiciled in Switzerland. The ETF is listed in the SIX Swiss Exchange. It is worth noting that this ETF is not compliant with UCITS legislation, meaning it cannot be passported for registration and commercial distribution to retail investors across the European Economic Area (EEA). As of this writing, the fund is authorised for commercial distribution in Switzerland and Liechtenstein. iShares uses physical replication to track the performance of the Swiss Bond Index Domestic Government 3-7 (note – total return). The reduced universe of Swiss federal government bonds allows iShares to fully replicate the underlying index, with the statistical weight of each bond in the fund’s basket reflecting their outstanding as a proportion within the 3-7y maturity bucket of the Swiss federal government bond market. As we write (e.g. early September 2014), the fund’s basket was made up of four bonds with weightings ranging from 20% to 30%. The ETF typically distributes dividends on a semi-annual basis, with recent historical data showing a Jan-Jul payment pattern. As of this review, this ETF does not engage in securities lending activities.

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The annual total expense ratio (TER) for this ETF is 0.19%. Additional costs potentially borne by investors and not included in the TER include bid/offer spreads and brokerage fees when buy/sell orders are placed for ETF shares. There are also rebalancing costs whenever the index changes composition.

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As of this writing, measured in AUM terms, the iShares Swiss Domestic Government Bond 3-7 ETF is the most popular of all ETFs providing exposure to this market.  

The only alternative to the iShares range of Swiss government bond ETFs is marketed by UBS. Launched in November 2010 and also using physical replication, the set of UBS ETFs offer exposure to the same maturity segments as iShares. However, UBS charge a lower TER of 0.15%. As we write, AUM for the UBS Swiss government bond 3-7 ETF lags iShares by a considerable margin.

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Über den Autor

Jose Garcia-Zarate  is an ETF analyst with Morningstar UK.