Election opportunity for Italian government bond ETFs

Jan 9th, 2013 | By | Category: Fixed Income

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Following the surprise resignation of Mario Monti, Italy’s Prime Minister, on 21 December 2012, Italian government bonds took a hit. In the immediate aftermath of his announcement, the country’s 10-year bond yield rose nearly 0.3 percentage point to 4.80%, pushing the spread over equivalent German bunds to 3.5 percentage points.

Election opportunities for Italian government bond ETFs

Nervousness surrounding forthcoming elections in Italy could create opportunities for government bond investors.

Although the bond-market punishment proved short-lived (Italian bonds have since recovered), the sell-off highlights the ongoing nervousness afflicting Italian debt. However, if this nervousness induces further sell-offs in the run up to elections, this could represent an opportunity for investors.

With Monti now running the country as caretaker leader, structural reforms are likely to be put on hold until after the elections, scheduled for February. Current polls suggest a victory for the left-leaning Democratic Party, headed by Pier Luigi Bersani, who would likely lead a centrist coalition government that included Monti.

While bond markets may have preferred a continuation of the Monti-led administration, a new government with a clearer electoral mandate for reform could, in fact, be a longer-term positive. This, coupled with the fact that Italian fundamentals are stronger than many other peripheral eurozone countries, could mean that further spikes in Italian yields provide an opportune moment for investors to buy into Italian government bonds.

The current yields offered by Italian bonds certainly are in attractive territory. The country’s 10-year bond, for instance, offers a yield approximately 2.2 percentage points higher than the equivalent French bond. This yield premium belies a number of factors in Italy’s favour. For example, Italy is running a primary budget surplus and fiscal austerity is set to ease; credit conditions have improved and Italian banks and households are not overloaded with debt; and recent data also suggest the economy may be improving. In addition, around two-thirds of outstanding government debt is held domestically, which provides strong demand even under increased political uncertainty. By contrast, France faces numerous challenges which it has barely begun to address.

For investors looking to take advantage of potential opportunities, exchange-traded funds (ETFs) provide an efficient means of achieving targeted liquid exposure at low cost. UK and European investors have a choice of three principal funds offering exposure to various segments of the Italian government bond market. These are the iShares Barclays Italy Treasury Bond ETF (SITB) and db X-trackers MTS Ex-Bank of Italy BTP ETF (XBO1), which offer broad exposure to Italian government bonds, and the Lyxor ETF MTS BTP 1-3Y ITALY Government Bond (MI13), which focuses on the shorter end of the yield curve.

The iShares fund is physically replicated and aims to track the performance of the Barclays Italy Treasury Bond Index. This index offers exposure to euro-denominated Italian government bonds with a minimum remaining time to maturity of one year and a minimum amount outstanding of €300 million. The fund, which includes bonds right across the maturity spectrum, has an average maturity of 8.28 years and a modified duration of 6.04. Its yield to maturity is 3.34%. The fund has 42 holdings. The fund is listed on the London Stock Exchange, Borsa Italiana and Deutsche Börse, and comes with a Total Expense Ratio (TER) of 0.20%.

The db X-trackers fund tracks the performance of the MTS Italy BTP – Ex-Bank of Italy Index via a fully-collateralised swap. This index offers exposure to all BTPs (conventional euro-denominated Italian government fixed coupon bonds) traded on the MTS bond trading platform. The index has a slightly lower duration than the iShares fund, meaning it is likely to be slightly less sensitive to potential interest rate changes. The fund offered a yield to maturity of 3.30% as of November month end. The fund is listed on the Deutsche Börse and Borsa Italiana, and comes with a TER of 0.20%.

Unlike the iShares and db X-trackers products, the Lyxor fund, which is also based on an MTS Italy BTP index, targets the short end of the Italian government bond yield curve, namely those bonds that have a maturity of between one and three years. Bonds with shorter maturities, such as these, tend to be less risky and less sensitive to changes in interest rate. However, reflecting this lower risk, the yields they offer are typically lower. The fund is listed on the NYSE Euronext (Paris) and is synthetically replicated. It comes with a TER of 0.165%.

US-based investors preferring to access Italian government bonds via a locally-listed product could take a look at the PowerShares DB Italian Treasury Bond Futures ETN (ITLY). This NYSE-listed exchange-traded note tracks the DB USD BTP Futures Index. This index measures the performance of a long position in Euro-BTP Futures, the underlying assets of which are Italian government bonds (BTPs) with an original term of no longer than 16 years and remaining term to maturity of not less than 8 years and 6 months and not more than 11 years as of the futures contract delivery date. The ETN has an annual fee of 0.50%.

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