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The iShares Core UK Gilts UCITS ETF offers investors exposure to the performance of the UK government conventional bond market. In our view, this ETF would work best as a core element of a UK-centric portfolio, offering the necessary counterweight to UK equity fund exposure, particularly useful in times of an economic downturn. In most cases fixed income holdings provide a steady and fairly reliable revenue stream via coupon and redemption payments. Those attracted by this latter property should be advised that this iShares ETF distributes dividends on a semi-annual basis.
This ETF covers the whole maturity spectrum of the UK government conventional bond yield curve, with around 35% exposure to gilts with maturity over 15 years, fitting with the long duration nature of the UK government conventional bond universe. Exposure to the entire maturity spectrum makes this ETF best suited to shield the overall investment portfolio against negative performance effects arising from market shifts across the yield curve, whether near-term tactical or long-term strategic in nature.
This ETF can also work tactically, either as a complement or a hedging tool for investment portfolios with exposure to other geographical areas within the fixed income universe, and particularly so the Eurozone. However, foreign exchange considerations would need to be taken into account, particularly so if the ETF is to be used as part of a hedging strategy.
Fundamentale Analyse
The strength of the UK economic recovery has been surprisingly positive, with GDP growth averaging 0.8% q/q in the five quarters to Q2 2014. This has prompted widespread upside revisions to growth forecasts for 2014 and beyond, with the UK now on course to be one of fastest-growing developed economies. The bulk of growth is being generated by domestic demand, mainly on a mix of services sector (i.e. financials) output and housing sector activity, all supported by a resilient labour market. However, the hoped-for rebalancing towards export growth has not happened. All the while, the UK government has been committed to a budget deficit-busting policy. Up to now a significant decrease in public borrowing has proved elusive and public debt has continued to grow. However, budget consolidation could be easier to achieve now that the economy is growing fast.
Despite the economic upswing, the abating of inflationary pressures and the ongoing wage growth squeeze in real terms has allowed the Bank of England (BoE) to retain a very accommodative policy stance. Interest rates have been kept at a historically low of 0.50% since March 2009. However, expectations for a normalisation of policy are building, with the first hike in rates pencilled in for early 2015. In any case, the BoE says that the tightening cycle, when it comes, would be very gradual, and likely towards a new normal for rates in the 2.0-3.0% area.
UK government bond yields have risen from the post-crisis historical lows, but still remain well below pre-crisis levels. In fact, for most of 2014 long-dated gilt yields have come down, partly pricing in the decline in inflation expectations. Besides UK specifics, the effects of the economic slowdown in the neighbouring Eurozone into H2 2014 are likely to have provided some additional support. In fact, the prospects of the ECB engaging in further monetary stimulus (e.g. QE) have the potential to also keep UK bond yields in check. However, overall, the path of least resistance for UK gilt yields remains biased to the upside in the long-run; particularly so once the BoE starts to hike rates.
Indexkonstruktion
The FTSE Actuaries Government Securities UK Gilts All Stock Index is produced by FTSE. The main purpose of the index is to calculate the level of yields in the market for UK government conventional bonds (i.e. conventional gilts). FTSE considers for inclusion all fixed coupon conventional gilts (i.e. excluding inflation-linked gilts) irrespective of maturity which are quoted on the London Stock Exchange and are of an issue size to allow for an effective market. The index is calculated at the end of each business day on a total return basis. Yields are calculated by fitting a curve to the redemption yields for all eligible gilts. The redemption yield for each gilt is calculated using gross prices (i.e. including accrued interest) compiled and distributed by the UK Debt Management Office (DMO). Conventional gilts with unusual conditions, as well as convertible issues or with a special tax status are not eligible for the index. New gilts issued are included in the index at the close of the business day when the operation takes place. Gilts are removed from the index on their redemption date or when they join the DMO’s list of rump gilts (i.e. with too small an outstanding for an effective market). Alterations to nominal amounts outstanding are adjusted at the close of business on the day the DMO announces the change in nominal, or the day that FTSE becomes aware of the change.
Fondskonstruktion
This ETF was launched in April 2009 and is domiciled in Ireland. iShares uses full physical replication to track the performance of the FTSE Actuaries Government Securities UK Gilts All Stock Index. The restricted universe of bonds eligible to be part of the underlying benchmark index generally allows iShares to hold all its constituents in the ETF. However, differences in the statistical weighting of individual components between index and ETF may occur, although in our experience, they tend to be minimal. In any case, the ETF factsheet prefers to describe the replication methodology as “sampling”. An analysis of the ETF holdings at the time of this writing (e.g. early September 2014) showed the basked was made up of 43 bonds. In terms of maturity segmentation, around 20% of the ETF holdings (note – in % of the fund’s value) were short-dated (e.g. up to three years), 30% short-to-medium (e.g. 3-7 years), 25% long-dated (e.g. 7-15 years) and the remaining 25% ultra-long (e.g. over 15 years). This ETF pays dividends on a semi-annual basis, with historical payment data showing a May-November payment pattern. The dividend distributive nature of the fund produces a taxable event which varies in nature in relation to the legal status of the recipient and may thus have different implications in the ETF’s overall performance. This iShares ETF has UK distributor / reporting status, meaning that interest for UK resident investors is taxed as capital gain rather than income. UK individual investors holding this ETF under an Individual Savings Account (ISA) wrapper are exempt from any UK tax on gilts. UK non-resident investors are in most cases exempt from any UK tax on gilts. iShares may engage in securities lending in order to optimise the ETF’s tracking performance. BlackRock acts as investment manager on behalf of iShares. The amount of securities that can be lent out is capped to 50% per fund. The annual average on loan for this ETF in the year to end June 2014 was 33.3%. Lending operations are hedged by taking UCITS-approved collateral greater than the loan value and by revaluing loans and collateral on a daily basis. The collateral is held in a ringfenced account by a third party custodian. The degree of overcollateralisation is a function of the assets provided as collateral, but typically ranges from 102.5% to 112%. Lending revenue is split 62.5/38.5 between the ETF and BlackRock, respectively.
Gebühren
The annual total expense ratio (TER) for this ETF is 0.20%, which now stands at the top-end of the 0.12-0.20% TER range for ETFs offering exposure to the UK government bond market. 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.
Alternativen
iShares is by far the dominant provider with regards to ETFs offering exposure to the UK government bond market. Available alternatives lag substantially in AUM terms, even though some levy lower TERs.
The two longest running alternatives, namely the synthetic db x-trackers iBoxx GBP Gilts (TER 0.20%) and Lyxor ETF iBoxx GBP Gilts (TER 0.18%), launched in 2007 and 2010 respectively, never posed much of a challenge, with their combined AUM a tiny fraction of those held by the iShares ETF as of this writing.
The physically replicated SPDR Barclays Capital Gilt ETF (TER 0.15%) and Vanguard UK Government Bond ETF (TER 0.12%) - launched in 2012 - have proved more successful. Both are now ahead of the db x-trackers and Lyxor funds in AUM terms, although they still lag substantially behind the iShares ETF.
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