BlackRock’s iBond ETFs: Timely innovation Europe’s been waiting for

The fixed maturity range has several use cases for investors, but what happens when it reaches maturity?

Theo Andrew

Bonds stopwatch

Investors in Europe have been screaming out for innovation in the fixed income ETF market this year, with rising interest rates once again creating an attractive environment for the asset class.

Launching last week, BlackRock appears to have heeded these calls with a new range of bond ETFs offering exposure to investment grade corporate bonds with a defined maturity.

The four ETFs are:

“In Europe, we are excited by the interest rate environment and the market backdrop for fixed income and we are starting to see more ETF adoption,” Brett Pybus, global co-head of iShares fixed income ETFs at BlackRock, told ETF Stream.

“Coupled with the experience many investors had last year when the safest assets in investor's portfolios performed poorly, we are seeing a lot of interest in products with a fixed maturity that look and feel like a bond.”

While this is a first for Europe, the iBonds range has been available in the US since 2010 with 39 currently ‘live’ across US Treasuries, investment grade and high-yield bonds.

Labelled the ‘Ladder Tool’, they allow investors to pick specific points on the yield curve while offering the benefits of diversification versus investing in a single bond.

As a starting point, BlackRock said the three and five-year maturities seemed like a “reasonable place” to begin in Europe with a view to expanding the range should demand be similar to the US market while also looking to improve efficiency in the corporate bond market.

“We will continue to look at other areas of the market that might be of interest but investment grade felt like a natural place to start,” Pybus said.

“It is also a part of the market where ETFs offer a particular benefit because of the frictions in the underlying market, it can be a challenging part of the market to access, it is much harder to build a diversified portfolio of corporate bonds.”

So how do the ETFs work? And what are the use cases for investors?

How do they work?

The ETFs track Bloomberg indices of the same name and will use a sampling approach to hold bonds that mature in 2026 and 2028.

Investors will be able to choose between accumulating or distributing share classes, with income paid driven by the underlying portfolio of bonds, according to Pybus.

However, unlike holding a bond, the income is not fixed and will vary depending on the interest rate environment due to the broad range of bonds in the index.

As the ETF enters its final year and the bonds start to mature, BlackRock said it will rotate into short-dated euro sovereign bonds or US Treasuries “to maintain some yield and mitigate the cash drag”.

When ETF reaches the end of its maturity year, the product will be redeemed with investors receiving the final payment in cash, with the ETF then delisted.

The range will track respective Bloomberg indices which implement an ESG screen using MSCI data, meaning the ETFs are classified as Article 8 under the Sustainable Finance Disclosure Regulation (SFDR).

“One of the methodology challenges was to make sure we balanced the integration of ESG to ensure we are holding a broad and diverse universe of bonds,” Pybus added.

Who are they for?

The 'Laddering Tool’ is one of the leading investment cases for the ETF range, giving investors the flexibility to match their client’s portfolios to their needs.

“Advisers will use these ETFs to roll their clients up the yield curve,” Pybus said. “A lot of what we have seen in the US is the laddering concept, where they will pick specific points on the curve and actively manage their clients' portfolios using iBonds to access slices of the corporate bond market.”

He added investors are using the products to match liabilities as they can be assured the bonds will give in income over the set period of time. “It could be your children's university tuition which you know is going to be due in five years,” Pybus said.

Ben Seager-Scott, head of multi-asset funds at Evelyn Partners, agrees, adding they could be very useful tools for those portfolios that are managing outcomes in a life-styling approach.

Furthermore, he said wealth clients have also shown interest in using them as “portfolio building blocks, another tool in the toolkit” while also a low-cost option for fee-based advisers, a market he believes is growing in Europe.

It is also worth noting BlackRock launched an iBonds ETF in 2015 for an institutional client which reached maturity in 2018, but “did not see the appeal from broader wealth markets” in bringing a suite to the market.

The investor view

ETF investors in Europe have broadly welcomed BlackRock’s new range with many describing the fixed income space on the continent as “ripe for innovation”.

James McManus, CIO at Nutmeg, said the ETFs will widen the asset allocators' toolbox and should be attractive to investors.

“These strategies marry the many benefits of ETFs – easy access to diversification chief among them – with the prospect of a fixed maturity structure,” he continued.

“For those using single bond assets to target fixed income curve exposure, or for liability matching, the diversified nature of these products and on-exchange pricing should be attractive.”

However, he questioned whether investors would hold the strategies until maturity with the proceeds held in cash equivalents as the underlying bonds mature.

While the rotation into sovereigns as the bonds mature does limit the cash drag, McManus said this would transform the ETFs from corporate bonds to money market or government bonds, which could affect investors' asset allocation.

Pybus told ETF Stream between 5-25% of clients in the US redeem ahead of the final year of maturity.

“The behaviour from clients is that you tend to see inflows at inception or early in the product’s life cycle, then it tends to be fairly stable,” Pybus said. “Between 5-25% of clients have then redeemed ahead of the final year of maturity, you are not locked in.”

Echoing his thoughts, Abdelhakim El Attar, multi-asset portfolio manager at Eres Gestion, added the challenge will be “managing the subscription and redemptions” of the ETFs but said it was an “interesting innovation” for the ETF space.

Meanwhile, Stephen Kemper, chief investment strategist for Germany at BNP Paribas Wealth Management, said the range, with a total expense ratio of (TER) 0.12%, offers an “interesting solution for cost-sensitive clients who wish to harvest the currently attractive yields for an extended period of time”.

Pybus added: “As fixed income becomes a bigger part of investors' portfolios, we see this as bringing innovation to the market and giving investors a different way to gain that exposure.”