Covered Bond ETF - A combination of covered-bond security and yield prospects
In difficult times, the advantages of high-quality investment products become apparent. This advantage is certainly true of the covered bond. It is a product with a long tradition, which has many unique qualities: a legal basis, strict oversight, and high-quality securities. In view of the breadth of the German covered-bond universe, the Xtrackers makes this attractive asset category available to a wide range of investors.
Every covered bond is backed by real assets. These are mostly real estate assets, but can also be ships, or aircraft. This backing is also used for other financial instruments, so-called asset-backed securities (ABS). The key difference, however, is that a covered bond is a debt issued by a regulated bank, and the securities which back it remain on the bank's balance sheet. They are never outsourced to special-purpose entities. So-called Pfandbrief ("covered bond") banks are subject to particular oversight by the German Federal Bank, and by the Federal Financial Supervisory Authority (FFSA). In the theoretical case that a Pfandbrief bank becomes insolvent — which has not occurred for over 100 years — the bond holders have a legal priority (the "Insolvenzvorrecht"), since the securities which back the covered bonds are not part of the insolvent estate, and are used solely to satisfy the claims of the bondholders.
Fluctuations in the value of the securities have only a minor effect on covered bonds. Because only 60% of the value of real estate- and ship mortgages can be used as security, there is a sufficient buffer. These multi-layered provisions have led to covered bonds retaining their function as a solid and attractive form of refinancing, even through the market turbulence which has prevailed since mid-2007.
The iBoxx Germany Covered Bond Swap UCITS ETF 1C represents the entire German covered bond market, whereby certain selection criteria are taken into account. The calculation of the index is based on the bid- and ask prices, which are provided by participating banks.
Examples of Pfandbrief banks whose bonds were accepted into the index are the Eurohypo AG, the Landesbank Baden-Württemberg, the Deutsche Genossenschafts- und Hypothekenbank and the Depfa Deutsche Pfandbriefbank.
Furthermore, other bonds which display similar risk- and creditworthiness profiles, and are considered to be covered bonds by the market, have also been accepted into the iBOXX € GERMANY COVERED® index. The criteria by which the iBoxx technical committee judges the status of a bond are structure, trading data, issue process, liquidity, and spread level.
Within the index, the individual bonds are weighted on the basis of their outstanding volumes. In order to be accepted into the index, the bonds must have a remaining term of at least one year on the day on which they are reweighted. All bonds must have an outstanding volume of at least one billion Euro, in order to be considered for inclusion in the index.
The index is calculated on the basis of the total return, that is, coupon payments are reinvested in the index. Coupon payments, planned part-repayments, and unplanned full repayments are held as liquid funds, and reinvested in the index during the course of the next reweighting.
In the case of Xtrackers, covered-bond ETFs (like all fixed-income ETFs) exclusively invest in bonds with high creditworthiness and then SWAP the performance of these bonds against the performance of the relevant index.