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Which ETFs Will Be Boosted by the Bond Buying?

The outlook for the UK economy has been revised down in the wake of the vote in favour to leave the EU. To address that risk, the Bank of England decided at its August 2016 meeting to provide further monetary stimulus, bringing interest rates to a new historical low of 0.25% and expanding the quantitative easing programme by £70 billion, of which £10 billion in corporate bonds and the remainder in the gilts.

Judging by initial market trends, the new tranche of QE – not to mention the expectation that it might be further increased – could exert considerable downside pressure on gilt yields across the maturity spectrum for the duration of the programme of purchases.

This is exactly what the Bank of England wants. Indeed, forget gilts – easier said than done for the less than cheerful pension fund and insurance sector – the ultimate goal is to entice investors to switch from government onto corporate debt, with a view to ease financing terms as much as possible for UK Ltd to ride out these uncertain times. So, corporate debt – assuming that QE achieves its goal – is where the key tactical opportunity may lie.

Why Go Passive for Fixed Income?

Passive funds are particularly adept in these situations. When the entire market is being effectively driven by a policy-maker power-buyer such as a central bank, there is next to no value that an active manager can add to the mix. Going low-cost passive and tracking the market becomes the default option.

Investors considering this, non-yield but capital appreciation chasing, tactical opportunity can choose from a range of passive funds – both ETFs and traditional trackers – providing exposure to the GBP-denominated corporate bond market. In ETF space we find iShares Core GBP Corporate Bond (SLXX) and SPDR Barclays GBP Corporate Bond (UKCO). They are physically replicated and come with an ongoing charge of 0.20%.

Meanwhile, in the traditional tracker space we find Vanguard UK Investment Grade Bond Index and BlackRock Corporate Bond Tracker. These two funds have a Morningstar Analyst Rating of Bronze and levy ongoing charges of 0.15% and 0.17% respectively. A slightly cheaper option at 0.14% is L&G Sterling Corporate Bond Index.

Aside from cost, there are differences in the way the benchmarks linked to these funds provide exposure to the sterling corporate bond market. In broad terms, according to our research, the indices tracked by the two ETFs would be a pure play on corporate bonds, whereas those followed by the traditional trackers go beyond corporates to also tap, albeit peripherally, into agency and quasi-government sterling bond markets.

What About Inflation?

Investors tactically playing the Bank of England QE card, should not overlook that there is an additional objective to the policy; namely that of keeping the sterling exchange rate as low as possible. This is expected to produce a – hopefully temporary – spike in inflation which may even go above the 2.0% policy target. The Bank of England sees this as a necessary trade-off and so it won’t fight it off. As a result, alongside any tactical bet on corporate bonds, it might make sense to also shield one’s portfolio against the expected inflation pick-up.

Here too, passive funds come in handy. Amongst the possible choices, we find L&G All Stocks Index Linked Gilt Index, a Bronze-rated tracker carrying an ongoing charge of 0.14%, and for those more inclined to go the ETF way, iShares GBP Index-Linked Gilts (INXG), which although levying a higher 0.25% has produced comparatively higher returns so far this year.

Source Morningstar. Jose Garcia-Zarate | 12/08/2016

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