The ProShares USD Covered Bond ETF: Covering All The Bases
One of the few ways for a retail investor to participate in the covered bond market. The fund features U.S. Dollar denominated AAA rate covered bonds. The fund is actively managed, with total annual expenses of 0.35%. Anyone who knows the game of baseball will tell you that in order to play effective defense, the team must know how to keep the bases covered at all times. It’s not as simple as it sounds. It depends on the baserunners, on what bases and then what to do on the next pitch. Covering all the bases carries over to investing and choosing a fund while keeping that well-worn baseball axiom in mind. According to European Covered Bond Council : …Covered bonds are debt instruments secured by a cover pool of mortgage loans (property as collateral) or public-sector debt to which investors have a preferential claim in the event of default… In other words a covered bond is a bond whose cash flow originates from other bonds or loans called a ‘cover pool’. This might remind some investors of the infamous ‘collateralized’ or ‘securitized’ mortgage backed securities, but covered bonds are not that. First, a covered bond is not an ‘off-balance-sheet’ asset. It is an obligation kept on the balance sheet of the issuer; it is a ‘bond’ in every way. The issuer bears full accountability for the bond and the payments. In other words, the bondholder has full recourse to the issuing credit institution, if need be. Second, the bondholder also has a claim to the covered pool, senior to unsecured creditors. Third, it is the responsibility of the issuer to maintain sufficient assets in the cover pool to satisfy the claims of bondholder during the life of the bond. Lastly, to be able to issue a covered bond, the issuing institution must be an accredited, regulated institution. What it amounts to is that all the bases are covered. At this point, it’s necessary to mention a little known general fact about bonds: a bond may be issued in a currency other than the issuer’s sovereign currency. So, for example, an accredited, regulated European institution may issue U.S. Dollar denominated bonds , even if the native currency is the Euro. There are various reasons for this. For example, a U.S. Dollar denominated bond might be intended for a particular segment of the U.S. market; a pension fund for instance. Also, advanced economy nations may issue foreign denominated bonds as part of a trade agreement. This is particularly true of emerging market nations trying to attract foreign, fixed capital investment. Most importantly, a foreign denominated bond is a hedge against originating currency volatility. One other critically important characteristic of this fund is that does not choose yield over risk. ProShares USD Covered Bonds ETF, ” focuses exclusively on the highest rated U.S. Dollar denominated bonds ” and ” is the only corporate bond fund in the United States with substantially all of its assets rated AAA. ” Thus the fund has an added measure of safety in a financial world rife with unsound fixed income investments. The fund first traded in May of 2012 and has been consistent on returns with a steady Net Asset Value as well as a steady flow of monthly distributions. (click to enlarge) The average dividend return for 2012 was $0.085491 per month for the 7 months of the fund’s inception year. In 2013 the average dividend was $0.0821472 per month; in 2014 it was $0.0847515 per month and for 2015 $0.0930747, to 7/1/15. Hence the dividend has been consistent since inception. The average NAV since inception is $101.42368 and the June 19 NAV close $101.53, hence about 0.108% above its average and 1.53% above its inception value. The dividends paid since inception total $3.159669 on the $100.25 per ETF share, or 3.1517895%, if purchased on the inception date. This is in comparison with the 3 year U.S. Treasury note’s 0.41% and the 30 year U.S. Treasury bond’s 2.80% secondary market yields on the fund’s inception date of 5/21/2012. Hence this fund with its AAA, rating had a better yield, to date, than a 30 Year U.S. Treasury bond if purchased on the same date. (click to enlarge) Dividend Distributions chart: data from ProShares The ETF market shares have returned -1.546% since inception, as of the June 29, 2015 close. This means that, currently, the market shares are trading well below the NAV, meaning the shares are selling at a 2.67% discount to the NAV. This is a rare event. The share price has traded at a discount on only 40 of the 785 days since inception or 3.82% of the time. It has traded at a premium on 96.13% or 745 days over the life of the fund. It’s possible that the ETF shares are selling at a discount to the NAV on expectations that the U.S. Fed is expected to tighten. If this is the case, the investor must consider the U.S. Feds plan to raise by small increments. The Maturity Distribution Chart demonstrates that the largest portion of the covered pool, 55%, is held in 2 to 4 year bonds, and 34% in 0 to 2 year bonds. Since the fund is actively managed , the higher likelihood it will anticipate and adjust quicker than a rules based passively managed fund. It is interesting to note the fund’s performance during the global bond selloff from about the middle of April until the beginning of June. The NAV closed at a high of $102.10 on April 15, paid a dividend of $0.087976 on May 11, $0.101797 on June 9 and closed at a low of $101.04 on June 10, averaging 101.57, or about $0.15 above its average since inception. The average dividend paid was $0.09489, $0.01274 above its average since inception. The ETF share price closed at a high of $102.15 on April 22 and closed at a low of $99.39 on June 8 a decline 2.70%, or $2.76 from the April high. Most recently, the ETF shares closed at $98.70 on July 1, while its calculated NAV as of July 1, was $101.41. It’s important to note then, the market shares are trading well below the NAV, a discount of -2.67%. This is a rare event. The share price has traded at a discount on only 30 of the 740 trading days since inception or 4.05% of the time. It has traded at a premium on 95.95% or 700 trading days over the life of the fund. There are currently 25 covered bonds in the fund, and a cash position of $48285.95. The weighted average yield to maturity is 1.48%. The trailing twelve month yield is 1.06% and the annualized yield based on the last distribution is 1.18%. The fund’s net assets as of June 19 are $6.563 million. It’s worth noting that the tracking index is comprised of 44 issues, has a weighted average maturity of 3 years, a weighted average yield to maturity of 1.52%. This indicates that this actively managed fund is more efficient than the unmanaged index. Almost all of the covered bonds are “144A” bonds. Investopedia defines SEC Rule 144A a modification of: … a two-year holding period requirement on privately placed securities to permit qualified institutional buyers to trade these positions among themselves … In other words, the rule creates a more liquid market for these securities. The fund’s largest holding is Australia’s Westpac Banking Corp (NYSE: WBK ) 144A 1.850% due 11-26-18. According to Westpac, its covered bond rating by Fitch is AAA and by Moody’s, Aaa. Just as a side note, a Seeking Alpha contributor Donald van Deventer recently updated his analysis of Westpac Banking Corporation noting that: … Westpac Banking Corporation has continued to be a prominent bond issuer in international markets… The bank ranks in the safest 10% of the world-wide banking peer group for default probability maturities of 5 years or more, but the banking sector is a risky one … The second largest market value holding is The Royal Bank of Canada’s (NYSE: RY ) 144A 2% due 10/1/18. Moody’s rating of the bank’s covered bond program is Aaa and Fitch ranks it at AAA. SpareBank ( OTC:SRMGF ) is a Norwegian Bank which, coincidentally, specializes in covered bond issuances. The cover pool consists of high quality single family residential mortgages. It must be emphasized that these are not securitized or collateralized off-balance-sheet debt instruments, but actual bonds for which the issuer bears full responsibility. Further, in the aftermath of the global credit bubble, the financial and legal consequences suffered by the rating agencies served to strengthen the quality of analysis and that of ratings. SpareBank 1 Boligkreditt mortgage-cover-pool, covered bonds, are rated Aaa by Moody’s and AAA by Fitch. Stadshypotek AB , is a Swedish mortgage lender and subsidiary of Svenska Handelsbanken ( OTCPK:SVNLY ), whose covered bond program receives an Aaa rating from Moody’s. Since it is a subsidiary, it should be noted that S&P rates the issuer Stadshypotek AA-; Fitch AA-, and lastly Handelsbanken receives ratings of AA- from S&P, Aa3 from Moody’s and AA- from Fitch. ING Groep (NYSE: ING ) of Netherlands, has a global reach but is mainly a European based bank. Their 144a 2.625% coupon, due 12/5/2022 receives Aaa from Moody’s, AAA from S&P and AAA from Fitch. ING’s ‘hard-bullet’ covered bonds are backed by Dutch Prime Residential Mortgages, the Dutch legal standard for mortgage cover pools. Covered Bond ETFs are a rarity in the ETF universe. iShares offers an investment grade , Euro denominated, Covered Bond ETF (ICOV.LN). The returns on the holdings are better, but the description refers to ‘ investment grade ‘ investments, meaning BBB or higher. Lastly, U.S. based Pimco in cooperation London based Source also markets a covered bond ETF (COVR:XTER) however it trades on the German DAX and in Euros. To some up, the ProShares USD Covered Bonds ETF (NYSEARCA: COBO ) offers investors a way to participate in an asset class not accessible to individual retail investors. Further, the fund has a strong bias towards highly rated covered bonds with the best possible yields. Further, the high rating bias extends to the ‘cover pool’ of securities. The fund’s performance during the recent global bond market correction demonstrated its stability. The ETF shares did lose value but the Net Asset Value of the fund remained well within its long term deviation, thus creating a discount arbitrage for the shares vs the NAV. According to the prospectus , the fund is actively managed by ProShares Advisors and the total fees, expenses waivers and reimbursements result in total operating expenses of 0.35%. If it’s expected that low rates of return are to be the new normal, this may be a good opportunity to earn surprisingly good returns and very high degree of safety. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.