iShares Core Sterling Corporate Bond [SLXX]
Steady yields?
Officially known as the iShares Core £ Corp Bond UCITS ETF (which is a bit of a mouthful), this ETF is the largest Sterling denominated Corporate bond fund in terms of assets.
The fund aims to track the Markit iBoxx GBP Liquid Corporates Large Cap Index which is comprised of Sterling denominated bonds, issued by corporations from around the globe.
As of the end of January 2021, assets held by the fund came to just under £2.2bn, so this is a large fund. A TER of 0.2% is reasonably competitive and low cost for a corporate bond fund, although higher than the 0.07% charged by the iShares UK Gilt (Government) Bond ETF.
It’s worth doing some research around the main features and risks with bond funds as opposed to equities as they are some key differences. My article here goes through some of the various key concepts.
The first bit of good news is that the bonds included within this ETF are in Pounds, therefore if you are a UK investor, there is no currency risk - unlike many other bond funds which invest in other currencies. That’s not to say that these are just UK based companies however - this ETF includes bonds from a variety of ‘blue chip’ companies (hence the Large Cap element') across the globe.
Indeed, approx. 20% of the fund is made up of bonds issued by just seven companies: HSBC Bank, Electricite de France, E.ON Energy, AT&T Inc, Glaxosmithkline, Wells Fargo & Barclays Bank.
In terms of exposure to sectors then, expect to see the majority from the more ‘value’ side of the company classification. Sector breakdown, comprising around 90% of the ETF as of early Jan 2021:
Very heavy exposure from the Banking sector - unsurprisingly, given the predominance of ‘large cap’ banks, and their need for large amounts of debt issuance as part of trading.
Its when poking around the detailed list of holdings when one of the main risks becomes apparent: Credit Risk.
As you can see in the below screengrab from the iShares site (scroll down, under ‘Exposure Breakdown’), you can see that just over 10% of the fund is comprised of bonds rated AAA or AA, which are the top two credit ratings available.
However, very few companies have an AAA rating (Microsoft and Johnson & Johnson being two which spring to mind), so it is not surprising that the majority of the bonds are rated A or BBB. Companies with these ratings are generally companies which are held to be credit worthy, or ‘investment grade’ in the industry parlance.
So these bonds should be fairly secure, although value may be impaired should credit issues affect a particular sector heavily - for instance the financial sector (see 2008 Financial Crash).
Distributions & Yield
This ETF has a yield to maturity (YTM) of 1.34% as of January 2021, which is low by recent historical standards but understandable given the ultra low rate environment which we currently inhabit. For example, the previously mentioned iShares UK Gilt Fund is showing a YTM of just 0.39%, so there is about a 1% difference in rates compared to ‘risk free’ UK government bonds. Note this isn’t the same as what you actually receive as income for holding the fund - which is the distribution yield.
Before investing, we need to think about the trajectory of interest rates and how this affects both the price AND yield of the fund.
Over the past few decades, global interest rates have been falling, which has boosted the prices of bonds whilst at the same time lowering yields.
Because the fund holds bonds of medium duration, the yield is boosted due to bonds purchased many years ago when rates were higher (and prices lower). As the fund purchases more recently issued bonds, the yields to maturity will be lower due to the lower rate environment we’re currently in.
What this means is that the dividend yield of this fund (currently 2.15% as of Jan 21) has been falling over time, whilst at the same time the price of the fund has been increasing. You can see this below with two graphs showing distribution yield (i.e. actual yield received by holders of the ETF) over time, vs. the price of the fund and the actual amount of dividends received over time.
If broader rates keep falling, then the price of this ETF should continue to rise and the distribution yield will continue to fall. Whether this will happen is anyone’s guess, but you would expect that once the Covid recovery kicks in that the economies should recover and this generally leads to rising rates.
Rising rates should lead to the prices of bonds falling, which means the price of this ETF declining - by how much is impossible to determine, but given the medium duration of the bonds (see below), there will be an impact.
What this means is that there may be a scenario whereby there is a rising rate environment which leads to a fall in the price of this ETF (and a slow rising of distribution yield).
The fall in the price of the fund may outweigh - in the short term - the value of dividends received.
A quick thought experiment:
The average (over past 8 quarters) annual dividend is around £3.50. The price of the ETF in June 2019 was about £147 per unit.
Currently, the unit price of the fund is just below £158 - i.e. around £11 higher than a year and a half ago. If you purchased a unit now, at £160, and the economic rate climate ‘normalised’ back to where it was in June 2019, the price of the bond may well fall to around £147. This isn’t to say that it will - but if rates do move higher, then the impact on price will be negative.
You would still receive dividends from the fund - somewhere in the region of £3.50 per year, and most likely increasing - but it would take just over three years of dividend payments to ‘recoup’ the £13 capital paper loss.
Bonds are generally a low volatility holding, and government ones especially are great to hold when going into a periodic financial crisis. But if and when rates start increasing, this will put pressure on the value of the holdings. Be warned.
Other Considerations
The effective duration of the fund (which attempts to give an idea of sensitivity to interest rate changes - remember, longer duration bonds are more sensitive to rate changes than shorter duration) is 8.76 years at the time of writing, so does have sensitivity to interest rate changes, albeit not as much as a more longer term bond fund which may have 10-20 year durations.
Physical replication is the name of the game here - the ETF purchases the underlying bonds, rather than relying on a sampled method or synthetic replication of the performance of the underlying index.
Whilst bonds are as a rule less volatile than stocks, Corporate Bonds - even high grade ones such as those contained within this ETF - often sell off during financial panics, and therefore are not regarded as ‘safe’ assets. You can learn more about the correlations between various asset classes here. Upshot is, corporate bonds will most likely sell off in tandem with equities (Best port in a storm? Long term government bonds).
Summary
This iShares Corporate Bond ETF offers a fairly low charge access to Investment Grade Sterling corporate bonds, with a distribution yield of just over 2%.
Risks include (but aren’t limited to) credit risk, correlation to equities during sell-offs and especially interest rate and duration risk.
As ever, the above should not be construed as investment advice, and investors should conduct their own due diligence before purchasing.
In addition, whilst every attempt is made to ensure accurate and up to date information, fund information is liable to change and updates may not be reflected in existing articles.
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