Lueth Erik LGIM ETF

ETFWorld interview LGIM: India and government bonds

LGIM is a global leader in ETFs and its products include ETFs dedicated to India.
And on the subject of India and government bonds, ETFWorld asked Lee Collins, Head of Index Fixed Income and Erik Lueth, Global Emerging Market Economist at LGIM, questions.

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Lee Collins, Head of Index Fixed Income, LGIM – Erik Lueth, Global Emerging Market Economist, LGIM

8 July 2024 ETFWorld – All rights reserved


ETFWorld : What is the current economic situation in India and what are the growth prospects?

Lee Collins – Erik Lueth : India has strong fundamentals with a close-to-balanced current account, one of the largest FX reserve stocks in the world and a hawkish central bank. Government debt is high at above 80% of GDP, though most of that is denominated in domestic currency.

Growth prospects are bright over the short- to medium-term. Exports are strong, propelled by services, the banking and non-bank sectors have been cleaned up and support a capex cycle upswing and the property market is rebounding strongly after the pandemic. India is forecast to grow 8% this year, the highest growth rate among large economies by a wide margin.

ETFWorld : What are the current monetary policies of the Reserve Bank of India (RBI) and how might they affect Indian government bond yields?

Lee Collins – Erik Lueth : The central bank of India has a high degree of credibility. Inflation is falling and within the target band; core inflation is in the lower half of the target band. The central bank is expected to cut the policy rate by 25-50bps over the second half of this year which should boost government bond performance.

A large part of local currency bond performance is driven by currency performance. Here it helps that the central bank sits on a large pile of foreign currency reserves which it is not afraid to use when the currency comes under pressure (e.g. during COVID). In our view, the INR is one of the least volatile currencies in the EM universe.

ETFWorld : Could you provide an overview of the key features of your L&G India INR Government Bond UCITS ETF?

Lee Collins – Erik Lueth : The ETF aims to offer investors a solution to gain exposure to the second largest emerging market local currency Government bond market.  As represented by the index which the ETF aims to track, the ETF invests in the Indian fully accessible route (FAR) bond market, whose bonds were specifically designed for foreign investors.  The ETF physically replicates the index buying bonds and does not use derivatives.

With India now on a path to being included in major fixed income indices, the ETF offers one potential route for investors to access exposure to both the currency and bond market.

The L&G India bond ETF was the first ETF launched in Europe in the asset class and it by far the largest ETF available with an AUM of almost $750m.  The next largest peer product is <$100m in size.

ETFWorld : What are the main Indian government bonds in the ETF portfolio and how are they selected?

Lee Collins – Erik Lueth : The starting point for eligible Indian Government bonds is defined by bonds contained within the index, or those that we expect to be included in the index or have recently been excluded from the index due to maturity reasons.  The index universe represents any Indian fully accessible route (FAR) bond which is greater than $1bn in size.  There are currently 31 bonds in the index and thus it is a relative small universe for a fixed income index.

Due to the small size and given the size of our ETF, we would normally expect to hold almost every bond in the index (although this does not necessarily mean all bond weights will match the index).  Currently there is only one index bond that we do not hold.

Bond selection on cashflows, rebalancing etc, is determined by which trades help us to best match the index risk characteristics alongside what are the most cost efficient bonds to trade.  Future index changes are also considered when deciding which bonds to trade.  For example we may look to start buying a new bond, which we expect to enter the index in the future, in advance of its inclusion date.

ETFWorld : What are the main risks associated with investing in INR-denominated Indian government bonds and how are they managed by the ETF?

Lee Collins – Erik Lueth : The largest risks for a foreign investor holding Indian Government bonds are quite typical of other similar EM fixed income markets.  Currency risk (assuming an unhedged exposure) and interest rate risk would be the biggest risk factors.

The management of risk within the ETF itself is managed relative to the index risk characteristics rather than absolute risk levels.  For example if the index increases its overall duration, we would also expect the ETF to follow this change.

ETFWorld : What is the historical performance of the ETF and what have been the main factors affecting returns?

Lee Collins – Erik Lueth : Since inception, the cumulative performance of the ETF has been +2% in USD unhedged terms.  The local returns of the bonds over the same period has been strong at almost +17% but this has been mainly offset by the performance of INR against the USD.

Foreign investors are subject to withholding (WHT) and capital gains taxes (CGT) when holding India Government bonds.  For an Irish domiciled fund such as our ETF, investment incurs WHT rates of 10% and zero CGT rates.  WHT at 10%, combined with an approximate average coupon on Indian bonds of 7% equates to an annual estimated tax cost of 70bps per annum.  Thus tax costs combined with the fund TER of 39bps means just over 1% per annum of performance impact.

It is important to note that the JPMorgan index assumes zero taxes so all else being equal, the fund should underperform the index by 70bps per annum due to tax costs in the real world.

ETFWorld : What are the total fees associated with the ETF?

Lee Collins – Erik Lueth : The TER of the ETF is 0.39% per annum.

ETFWorld : Is there anything else you would like to add about the ETF or the Indian bond market?

Lee Collins – Erik Lueth : It is also worth highlighting that our ETF also holds INR denominated supranational bonds.  Supranational bonds offer the same currency exposure and can be used to replicate some of the duration risk buckets.  At the same time supranationals offer a tax cost efficient alternative to Indian Government bonds as supras are not subject to any taxes.  Currently the fund holds approx. 6% of its NAV in INR supranational bonds.

An Irish domiciled ETF such as ours, offers a simple and cost efficient alternative to buying bonds directly.  Given different countries across Europe are subject to different withholding and capital gains taxes, it is important that any investors understand clearly which tax rate applies to them if buying bonds directly.  It maybe the case that gaining exposure via our ETF, which is Irish domiciled, is more cost efficient in tax terms.  We have clients that have chosen to use the ETF instead of buying bonds directly for this reason.

Learn more about LGIM‘s point of view

Source: ETFWorld.co.uk


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