First Trust has unveiled its second factor-based fixed income ETF in Europe with the launch of the actively managed First Trust Low Duration Global Government Bond UCITS ETF (FSOV NA).

The fund has launched with around 11% of the portfolio allocated to Italian government debt. (Photo © Nicholas Gemini)

Listed on Euronext Amsterdam, the fund aims to provide attractive levels of income and capital growth with low levels of duration risk.

To deliver on its income and growth objectives, the fund seeks to exploit carry and value factor premia present in sovereign bond markets.

The fund’s managers set out to achieve this by systematically scouring the global investable universe to identify and invest in the most attractive issuers and maturities based on relative yield and yield per unit of duration while using derivatives to isolate factor premia.

The fund has a relatively unconstrained security selection mandate and can invest in regulated markets worldwide. The fund’s managers expect emerging market securities to form up to 50% of the portfolio. The fund is similarly not constrained to invest in securities of a particular maturity band.

The fund’s managers are compelled, however, to purchase only in investment-grade bonds, although it should be noted that up to 30% of the portfolio can be invested in bonds that have subsequently lost their investment-grade status. This flexibility means the fund could exhibit substantially more credit risk than its performance benchmark index, the Bloomberg Barclays Global Treasury Index, which comprises only investment-grade issues.

To mitigate the currency risk that comes with the fund’s global mandate, the managers will use derivatives to hedge out exchange rate movements. This enables the fund to capitalize on the return and diversification opportunities that can be found in less-traversed areas of the global market without incurring material additional volatility.

To maintain accordance with the fund’s low-duration objective, the fund’s managers will use interest rate swaps to adjust the weighted average duration of the portfolio to between two and four years. By synthetically controlling duration, the fund’s managers can allocate to the most attractive points on a yield curve while maintaining a consistent target interest rate exposure. By contrast, the duration of the Bloomberg Barclays Global Treasury Index is 8.46 years (as of 31 October).

The fund has launched with 30 holdings, the top ten of which currently account for over 50% of the portfolio. These include sizeable positions in Italian, Spanish, Belgian, Danish and Israeli sovereign debt. There are also significant holdings in Columbian, Peruvian, Hungarian and Polish government debt reflecting the fund’s considerable geographic diversification (and exposure to lesser-quality credit) compared to traditional market value-weighted benchmarks. The Bloomberg Barclays Global Treasury Index dedicates more than half (57.75%) its exposure to bonds from the United States and Japan.

Commenting on the launch, Derek Fulton, Chief Executive Officer at First Trust Global Portfolios, said, “In a world of compressed yields, the fund aims to meet the growing demand for innovation and factor-based investment within fixed income. The use of these transparent, robust and repeatable processes, combined into an ETF structure, offers a marrying of two great innovations and an attractive solution for asset allocators looking for diversification in fixed income. We are delighted to be bringing this ground-breaking new product to market.”

Fulton continued, “True innovation in fixed income has, up until now, not been as widely adopted as in the equity ETF market but is undoubtedly gaining momentum.  Until recently investors’ choices have been limited to the star active manager or the market-cap-weighted passive benchmark solution. Investors or asset allocators searching for diversification can be hamstrung by the highly concentrated nature of the benchmark, which is often magnified by growing debt weighted schemes that overweight the most indebted countries.”

The fund trades in euros and comes with a total expense ratio of 0.45%. It has been seeded with €2 million.

It comes two years after First Trust rolled out its debut European domiciled fixed income ETF, the First Trust FactorFX UCITS ETF.