Euro Bond ETFs: Big Yields, Big Risks

by on November 30, 2011 | Updated November 21, 2012 | ETFs Mentioned:

Europe has been in the spotlight throughout the last several months as the continent has fought an increasingly desperate battle to ward off a wave of sovereign debt defaults that could ultimately lead to the end of the euro. While much of the attention–particularly from international investors–has focused on tumbling stocks, bond markets across the euro zone have been also been feeling the pressure. The recent volatility has weighed heavily on bond markets as well, as uncertainty over the ability of some large European countries to make good on their financial obligations has pushed up borrowing costs dramatically [see Three Long/Short Ideas For Euro Zone Debt Drama]. While the countries facing the most immediate and severe cash crunches–members of the PIIGS bloc–have been impacted most directly, the more “stable” countries are also seeing their costs of borrowing rise.

Italian bond auctions for three-year notes have recently sold at yields of nearly 8%, with ten-year debt yielding closer to 7.6%. Those borrowing costs are widely seen to be unsustainable, putting additional pressure on the shifting Italian government to come up with ways to cut spending drastically. Even Germany, viewed as one of the most fiscally stable economies in the region, has seen difficulty in raising capital needed to fund its government. In a recent auction nearly a third of German bonds up for sale went unsold, a remarkable scenario that would have been unbelievable just a few years ago [see Actionable ETF Trading Ideas].

With yields approaching euro era highs in many countries, there are some attractive opportunities out there for those who believe that Europe will ultimately survive the current sovereign debt crisis. Below, we profile a handful of ETFs that tap into European debt, providing investors with a high risk/reward trade opportunity: 

SPDR Barclays Capital International Treasury Bond ETF (BWX)

This ETF casts a wide net, including both developed and emerging markets in the underlying portfolio (though it is tilted towards advanced economies). BWX actually has a relatively light allocation towards the “trouble zones” of Europe, focusing instead on Japan (24%), the UK (12%), France (10%), and Canada (5%) [see BWX Holdings].

BWX currently has a 30 day SEC yield of only about 2% and maintains a modified adjusted duration of slightly less than seven years.

iShares S&P Citigroup International Treasury Bond Fund (IGOV)

This ETF seeks to capture the performance of treasury bonds issued in the local currencies of developed ex-U.S. countries. Although the fund’s weighting methodology is designed to limit the amount of exposure to countries with higher levels of debt outstanding, IGOV does have a significant allocation to higher-risk Japanese and Italian debt securities, which account for approximately 24% and 8% of the fund’s total assets, respectively [see Using ETFs To Build A Complete Bond Portfolio].

IGOV currently has a relatively high 30 day SEC yield of about 5% and maintains a weighted average maturity of just over 8 years [see IGOV Realtime Rating].

PowerShares DB Italian Treasury Bond Futures ETN (ITLY)

ITLY offers investors an alternative way to tap into the Italian government bond market by utilizing the exchange-traded note structure. This ETN tracks the DB USD BTP Futures Index, which seeks to capture the performance of a long position in Euro-BTP futures. The underlying assets of Euro-BTP futures are Republic of Italy-government issued debt securities (BTPs).

In a recent government auction, investors saw yields on Italian bonds skyrocket to 7.89% on three-year bonds and 7.56% on ten-year bonds, marking new record level highs.

WisdomTree Euro Debt Fund (EU)

This ETF is designed to provide investors with pure play exposure to European debt markets. EU invests in high-quality, short-term, euro-denominated debt securities, which have an average portfolio maturity of 60 days or less [see EU Fact Sheet]. The fund has a tilted allocation towards the non-“troubled” euro-zone countries, which include Germany (20%), France (19%), and Luxembourg (12%) [see Free Report: How To Pick The Right ETF Every Time].

Since EU is primarily invested in “safer” European countries, its underlying debt securities currently produce a 30 day SEC yield of only 2.3%.

Germany Bond Index Fund (BUND)

This ETF is designed to offer investors exposure to the German bond market, which is considered to be the benchmark for low-risk European debt. The fund’s underlying assets are comprised of euro-denominated investment grade debt securities issued by German entities, including both government and corporate bonds.

Since BUND was launched in late November, the fund’s performance data will not be available until the end of this quarter [see Six Noteworthy ETF Innovations]. Currently, the German 10-year note is yielding approximately 2%.

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Disclosure: No positions at time of writing.