State Street Debuts Two Bond ETFs

State Street, the Boston-based ETF issuer behind some of the country’s most popular exchange-traded products is back debuting more funds, launching two more ETFs earlier this week. For the most part the firm has been focused on equity and multi-asset funds so far in 2012, but appears to be at least temporarily shifting its focus back to the fixed income market.

These launches mark just the second and third bond ETFs from the company this year but come after a wave of other fixed income products have hit the market from various other issuers. This could suggest that the focus in the ETF industry is beginning to shift to fixed income for the time being, and especially towards more novel or niche products (see Play Europe with This ETF Pair Trade).

State Street’s launch could be a great example of that since both funds provide exposure to segments which are often overlooked by ETF investors; the crossover segment of the bond market, and the emerging market corporate debt space. Below, we briefly highlight some of the key points from this release for investors interested in possibly drilling down further in the fixed income segment of their portfolios:

SPDR BofA Merrill Lynch Crossover Corporate Bond ETF ( XOVR - ETF report )

This product tracks the BofA Merrill Lynch US Diversified Crossover Corporate Index which is a broad benchmark of U.S. dollar denominated debt that is currently rated in the ‘BBB’ to ‘BB’ range. Qualifying securities must have at least one year to maturity, be fixed coupon paying bonds, and have a minimum outstanding of $250 million (read Three Bond ETFs For A Fixed Income Bear Market).

State Street believes that this range from ‘BBB’ to ‘BB’ rated securities is the bond market’s ‘sweet spot’, consisting of notes that often times straddle the line between investment grade and junk. Sometimes, the bonds can even be rated junk by one agency and investment grade by another, while others can ‘crossover’ from one camp to another, hence the name ‘crossover bonds’.

The firm also believes that this space offers a nice mix between yield and risk, focusing on the lower rated securities in the investment world and the higher rated ones in the junk space. Furthermore, duration is also a medium risk factor for many of the securities so interest rate sensitivity shouldn’t be too bad for the overall portfolio.

Lastly, since the product offers such mixed exposure, State Street also claims that the market may reduce the need to rebalance among the various types of corporate bonds as it represents a relatively stable bridge between the two well-known groups of investment grade and junk (see Are The Fundamental Bond ETFs Better Fixed Income Picks?).

The product also looks to charge investors just 30 basis points a year in fees, which is in-line with other products in the bond space, although it is higher than some of the less specialized funds out there. In terms of the index, industrial bonds dominate, while the average yield to worst is a respectable 4.8%.

SPDR BofA Merrill Lynch Emerging Markets Corporate Bond ETF ( EMCD - ETF report )

This product has a much broader focus than its crossover counterpart, instead seeking to provide exposure to a broad range of corporate securities from various emerging markets around the globe. This is done by following the BofA Merrill Lynch Emerging Markets Diversified Corporate Index which a benchmark of developing market corporations that have issued dollar-denominated debt (also see Go Local With Emerging Market Bond ETFs).

To be included in the benchmark, the issuer must primarily be exposed to a nation outside of the FX G10, Western Europe, or American/European territories. Securities lower than “CC” are also removed, while bonds must have at least one year to maturity and have at least $500 million in outstanding face value.

In total, the underlying index has about 450 securities in its basket, and it has a modest yield to worst of roughly 5.4%. Total costs for the fund come in at 50 basis points a year, while no one security makes up more than 1.2% of the underlying index (read Van Eck Debuts Emerging Markets High Yield Bond ETF).

Exposure from a country perspective is focused on Brazil (19.7%), and Russia (15.2%), while Mexico (11%), UAE (6.6%), and South Korea (6.0%), round out the top five. China and India only combine to make up 8.3% of the total, a surprisingly small number that is actually overshadowed by combined holdings in Qatar and the UAE.

ETF Competition

For EMCD, the competition looks to be quite fierce in the emerging market bond ETF space. Currently, there are a host of competitors including two funds that have U.S. dollar denominated emerging market debt and more than $1.8 billion in AUM each.

Given this, the new State Street fund may have a difficult time in terms of accumulating assets off the bat, but the fund’s counterpart in the local bond space, EBND, has had great success so far, accumulating $190 million since its inception in February of 2011 (Read ProShares Debuts USD Covered Bond ETF).

XOVR is a bit of a wildcard, however, as the ETF space for crossover bonds is quite sparse. There is one product though that could be a foe, the iShares Baa-Ba Corporate Bond Fund ( QLTB - ETF report ) .

This product, which debuted in April of this year, charges investors 30 basis points a year in fees and has a similar focus on low rated investment grade debt and high rated junk securities. Yet, it has only accumulated $10 million in assets since its launch and sees volume of less than 10,000 shares a day.

This suggests that if there is enough interest from investors in the space, we could see XOVR pose as a big threat to QLBT in this niche of the bond world. Also importantly, it helps State Street keep pace with its competitors in the ETF world and prevent the company from falling behind in the fixed income market, something that arguably hasn’t been the strongest part of its product mix but could be an increasingly decisive aspect of issuers’ lineups going forward.

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