Fund will target gap in passive fixed income space

Tabula has launched a new fixed income ETF tracking the iTraxx European Crossover five year index. The fund follows hot on the heels of similar offerings from the firm, as it seeks to maximise on escalating inflows into CDS indices as well as the dearth of such products aimed at passive fixed income investors.

Michael John Lytle, ceo of Tabula, says that the vast majority of ETFs track equity exposure across various asset classes, with 20-30% of equity assets managed passively, while in fixed income this falls to under 5%. Additionally, many investors combine a range of fixed income factors into one investment, with both interest rate exposure and credit exposure.

“If you look at the state of ETFs today,” continues Lytle, “there are not many funds offering investors the ability to segment individual factors. Tabula’s first funds utilise CDS to offer credit exposure with a minimal amount of interest rate exposure.”

Furthermore, Lytle explains that trading single name CDS can result in a bid/offer spread similar to individual cash. With a CDX index, however, that tracks 75-plus equally weighted names, the resulting liquidity is generally significantly higher and bid/offer spreads are much lower.

As a result, Tabula’s new fund - which launched in December - provides exposure to high yield European corporate credit by investing in the iTraxx Crossover five-year index, rather than a basket of individual corporate bonds. Lytle adds that, “…The fund also benefits from the high degree of liquidity in the index, which sees US$1.8bn traded on the average day. This means that you can do a large amount of trading without impacting market prices or spreads.” 

There are also further benefits to trading CDS indices through an ETF, such as the lower barrier to entry that many investors face when looking to trade CDS products, exemplified by Lytle’s estimate that only around 250 European investors regularly trade CDS. Part of this is due to the onerous requirements involved before firms can trade CDS, such as the signing of ISDAs with several counterparties as well as a large number of operational and administrative changes to company infrastructure.

“With an ETF” Lytle comments, “you buy shares in the fund, receive a daily net asset value and then sell the shares at some point in the future. The barriers to entry are much lower, but the exposure achieved is the same.”

Investing in CDS indices does also have its difficulties, such as managing the roll every six months when a new on-the-run-index is launched. However, Lytle explains that the credit curve tends to be positively sloped and that selling the shorter maturity position in the off-the-run index, and buying the longer maturity index, can create value.

He adds: “The off-the-run is 6 months closer to maturity and, all things equal, should be trading at a tighter spread - and therefore worth more - than where you bought it.  If you execute the roll correctly, you can capture value that is not generally accessible in the cash bond markets.”

Another issue with CDS indices, including iTraxx Crossover, is that evidence has emerged recently of significant basis risk relative to corporate bonds, making them inefficient hedges (SCI 23 May 2018), particularly in periods of recent volatility. Lytle doesn’t disagree, but adds that, with iTraxx, you get “pure credit exposure and high liquidity, which is difficult to create through any other trading position.”

He adds: “…It is worth noting that there is a basis between cash bonds and CDS. This means that the spread on CDS, and on a fixed-rate bond from the same issuer that has been interest rate hedged, is not necessarily the same. There are some technical reasons for the difference. When trading individual names this can be an issue.”

“However,” Lytle continues, “once you have 75 names there are offsetting movements in the basis on different names.  If you wanted to recreate the cash spread by buying hundreds of cash bonds and hedging the interest rate risk, you would introduce other sources of slippage and the underlying assets would be much less liquid.”  

In terms of where Tabula is positioning their business, Lytle says he does not wish to go head-to-head with large providers, like Blackrock. Instead, he wants to offer different exposures, like credit factor products, that are complimentary to the handful of products that have been successful to date.

With regard to the jurisdictions targeted, the firm has “passported” its funds to the UK, Nordics and German and French speaking countries, with all investors being institutional such as insurers, pension funds, asset managers, wealth managers and family offices. A large percentage of the client base will likely be asset managers controlling a lot of fixed income money, but which don’t have access to the type of products Tabula offers.

Looking ahead, Lytle is confident in the growing wave of interest in index-linked products and says that says that “generally” he sees an “escalation of broader flows into CDS indexes like iTraxx Main and Crossover and ETF investors deserve to have access to these exposures.

“Of course though,” he concludes, “we have plans for a much broader range of fixed income exposure and this is just the beginning.  We urge passive investors to watch this space.”

Richard Budden