There is a certain awe and wonder about this index. It one of the broadest indices available with exposure to over 23,500 securities from around 2,500 issuers across 24 local currency markets. Issuers come from across the fixed income spectrum; governments, government-related and corporates as well as asset-backed, mortgage-backed and commercial mortgage-backed securities.
Because of its sheer size, only a handful of ETF providers are able to track the index efficiently. For a smaller firm, the costs of running it would simply be too high plus a large team of fixed income managers covering the different markets is also required.
Antoine Lesne, head of SPDR ETF strategy and research at State Street Global Advisors (SSGA), estimates to just launch a global aggregate bond ETF firms need over $200m seed money.
Competition as to who can track this index the most efficiently is hotting up after Vanguard became the latest player to enter this arena by launching the Global Aggregate Bond UCITS ETF (VAGE) towards the end of June, ETF Stream revealed.
This launch takes the total tracking this monster index in Europe to four with the US giant joining rivals SSGA, BlackRock and DWS.
DWS was the first to launch in March 2014 with the €238m Xtrackers II Barclays Global Aggregate Bond Swap UCITS ETF (XBAG), over three years ahead of its nearest rivals.
XBAG is listed on Xetra, the SIX Swiss Exchange and the London Stock Exchange with a total expense ratio (TER) of 0.15%, 5 basis points more than its rivals.
Furthermore, the firm only offers hedged versions of the index, EUR for Germany investors, USD for Swiss investors and GBP for UK investors
What separates XBAG to the other three ETFs is it is synthetically replicated meaning the index tracking is outsourced to a counterparty, in this case Deutsche Bank.
For such a large, diversified bond index, Amanda Rebello, head of passive distribution for the UK at DWS, argues using a swap is the most efficient way to do it.
A swap has the advantage of matching the returns of the index net of fees and with such a large index that requires a lot of resources, this removes much of the heavy lifting.
However, the asset manager cannot take part in securities lending as it does not own the bonds and it means the firm’s portfolio managers cannot make small margin gains to improve the ETF’s tracking error.
Rebello adds: “We could do it physically, but we find that the best tracking on this underlying is achieved with the swap structure. Physical replication on this index would require very heavy sampling.”
Where DWS argues efficiency will be lost by tracking the index physically, the other three providers see this as an opportunity.
At 23,500 securities, the index is simply too big to fully replicate so providers, instead, use stratified sampling to avoid high costs.
Stratified sampling is when the portfolio manager splits the index into buckets of risk that they look to match; duration, credit spread and currency, in this case.
This method enables the portfolio manager to match the characteristics of the index without having to invest in every security.
The number of securities the three ETFs track varies. VAGE currently has exposure to around 11,000 bonds while the €465m iShares Core Global Aggregate Bond UCITS ETF (AGGG) tracks just 3922.
This is why, Lesne explains, providers need over $200m at launch because the tracking error for this "beast" of an index would simply be too wide as they would not have enough capital to invest in the required securities.
When SSGA launched the €298m SPDR Bloomberg Barclays Global Aggregate UCITS ETF (GLAG) in early 2018, the tracking error was 0.11% however, as issuance and inflows came in, the team were able to increase the number of securities purchased from 700 to around 2000 which has taken the tracking error down to around 0.05%.
GLAG and AGGG, Europe’s largest global aggregate ETF, are the only providers to offer unhedged versions of the index.
Lesne says currency risk is the first part of the index that is replicated exactly and there is “very little tolerance in terms of deviation”. Only then can the portfolio managers start looking at the bonds.
BlackRock’s AGGG is the only global aggregate ETF available in Europe that takes part in securities lending, which enables them to extract extra performance.
Vanguard does this for some of its products in Europe while SSGA avoids lending across all its fixed income ETFs. Lesne says this is because the European market does not have the appetite for stock lending, especially on the fixed income side where returns are poor.
Where Vanguard has looked to gain an edge over its competitors is by tracking a different index. The US giant tracks the Bloomberg Barclays Global Aggregate Float-Adjusted and Scaled index as opposed to the Barclays Bloomberg Global Aggregate Bond index.
The reason the firm chose this index, Caroline-Laure Negre, fixed income manager at Vanguard, says is because it gives a better gauge of liquidity in the market as it removes holdings that are not available to trade freely. Therefore, this index "insulates" from securities with distorted prices due to a significant supply reduction, she explains.
At a country level, the main difference VAGE is less exposed to Japan (5.9%) and to compensate there are increased weights across the US, France, Germany, Canada and Italy.
Each ETF provider offering exposure to this monster index does so in a slightly different way so it is important investors do their due diligence to work out which methodology suits their requirements.
However, the fact investors can now gain exposure to 23,500 securities for just 10 basis points highlights how far “passive” investing has come in recent years.
ETF Insight is a new series brought to you by ETF Stream. Each week, we shine a light on the key issues from across the European ETF industry, analysing and interpreting the latest trends in the space. For last week’s insight, click here.