Established last year, Tabula Investment Management draws from the experience of its founders to provide innovative fixed income investment solutions. Although the macro fundamentals of fixed income are strong, there is a need for more thoughtful passive solutions that can help investors derive more value from this asset class.
The ETF market was born to deliver passive exposure to baskets of assets. The first ETFs tracked broad equity indices and were traded like equities by cash equity desks and sold by equity salespeople. Equity ETFs can be a simple and efficient, easy to price and trade. However, when providers turned their attention to fixed income, the questions weren’t just about which parts of the market were interesting, but also about how best to gain exposure.
In fixed income, ETFs have been a success story with a twist – there are over 400 European ETFs but almost half the assets are in only 30 funds. This suggests a lot of unsuccessful experiments as providers try to work out what investors want. Nonetheless, large investment grade bond ETFs have brought multiple benefits to the market. As well as giving investors access to a broad range of companies, coupons and maturities in one transaction, they have also created pools of bonds that can be traded by creating and redeeming shares in the fund.
However, large cash bond funds are only part of the solution when offering passive investment vehicles. Fixed income is a challenging asset class to index, consisting of a series of highly disparate sub-asset classes, which further contain within them a dizzying range of securities; there are nine million fixed income securities and counting. Finally, when you identify the securities you want, it is very difficult to get information on trading activity, availability and pricing.
While there may be challenges, the opportunities for investors are significant. Fixed income securities typically offer more controlled returns than equities and give exposure to different parts of the balance sheet with a reduced correlation to equity returns. The age-old assertion that equities outperform fixed income over most timeframes is too simplistic particularly if you adjust for risk. And, increasingly, techniques like factor investing, which have been practised for decades by specialist fixed income managers, can be made available to multi-asset investors via ETFs.
In Europe, credit products with reduced interest rate exposure have been a popular theme. Some funds have limited the duration of their bond holdings while others have focused on floating rate notes or hedging interest rate risk by selling futures. The fixed income market has created an instrument focused on this risk factor; CDS offer credit spread exposure without significant interest rate risk – but this is a relatively new tool to ETF investors.
Equally CDS indices trade more liquidly and with tighter bid/offer spreads than cash bonds. As a result, they offer more effective mechanisms for managing market exposure. As an example, Tabula has just launched a fund offering the ability to hedge high yield exposure, which can be particularly hard to execute through cash bonds.
All these dynamics mean that fixed income ETFs are only beginning to come of age. The next leap forward will come from providers who are focused on the asset class and have the in-depth knowledge to understand and deliver the opportunities.
There has never been a better time to be an investor looking for passive fixed income exposure.
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