Tabula's Lytle: Only using long products is like a toolbox full of screwdrivers

George Geddes

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Michael John Lytle, CEO of Tabula Investment Management, has stressed the importance of incorporating an array of different exposures in the "toolbox" during periods of extreme volatility.

Highlighting this, the Tabula European iTraxx Crossover Credit Short UCITS ETF (TECS) has been one of the best performing ETFs on the European market during the coronavirus crisis returning 16.8% since the end of February, as at 23 March.

The performance has been driven by TECS's short exposure to high yield European corporate debt, which has been impacted by growing fears over the coronavirus threat, through credit default swaps (CDS).

Most fixed income ETFs in the market, as well as equities, have been trading at a significant discount due to liquidity issues which Lytle said does not impact CDS in the same way.

While they are limited, he added CDS contracts are the "go-to place" for investors when markets suffer volatility as the price of a CDS readjusts to where the market is really going while cash bonds play catch up.

Fixed income ETFs have been trading at prices much below their net asset values (NAV) as the markets struggle amid the coronavirus outbreak, but Lytle said this is not the fault of the products themselves.

“The NAV discounts have been much more of a reflection on how the NAV price is being calculated rather than being a true reflection of fixed income ETFs being off the mark.”

He added NAVs are calculated by data providers with the data sourced from banks and market makers which only trade a small fraction of the available bonds in the market. This portion gets even smaller in a fast market as we have seen over the last month, but not all bond ETFs are struggling to perform.

Amid the coronavirus pandemic, government bond ETFs have continued to perform while riskier parts of the bond market have been hammered. So why pick a short position on a riskier fixed income product over a low-risk government bond exposure which has been thriving from recent events?

Assessing the long-term impact of coronavirus

“Picking low-risk government bonds over a short position on corporate bonds are not symmetric choices,” Lytle said. “The correlation between government bonds, equity and credit is not -1. There might be a negative correlation in a volatile market but at most, it will be 5-10%.”

The majority of products, particularly in fixed income, offer a long exposure which means it is easier to switch out of a corporate bond ETF into a government bond ETF but Lytle argued investors could get much more out of using short products.

“While there are about 400-500 fixed income ETFs available globally, most of the money has been in about 30 of them which are typically long cash products,” he continued. “They are good building blocks but they are not enough. It is like having a toolbox full of screwdrivers.”

Lytle described fixed income products like the Barclays Aggregate index as a “kitchen sink product”. It is comprised of thousands of bonds across several asset classes within fixed income but does not add any specificity to the investor’s objective.

Despite investors being able to capitalise on declining European corporate bond markets with the use of TECS, there will be periods eventually where performances begin to rally again and investors will seek long exposures and move assets away from short exposures. However, Lytle is prepared to have products with little assets under management.

“When I was at Source, we had between 80-100 products and we did not expect to have money distributed across all of them,” he stressed.

Tabula has four other ETFs available in addition to TECS which offers long exposures with the firm planning to launch another five ETFs in 2020, two of these in Q2.

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