Although Germany remains the strongest and most important economy in the euro zone, it is slowly being sucked into the quicksand along with its more free-spending neighbors. While German government bonds, popularly known as ‘bunds’ have long been the safe haven investment in the region—much like U.S. Treasury debt here—there is growing concern that this perception may be rapidly fading. At the very least, investors no longer seem willing to buy up bonds with such anemic yields in the region, especially with the current economic headwinds.
Thanks to this trend, the most recent auction of the bunds, in which the German government attempted to sell 6 billion euros in 10-year debt, failed, with bids totaling just under 3.9 billion euros. This situation forced the central bank to retain close to 40% of the offering and marked the sixth time in the last eight auctions that the Bundesbank has been forced to take some of the supply. Furthermore, the ratio of total bids to accepted bids was just 1.07, the lowest in the euro zone era, while the ratio of debt taken by the central bank was nearly double the average over a similar time period. “It was awful,” said Nick Stamenkovic, fixed-income economist at RIA Capital in Edinburgh. “It just shows that investors are not only shying away from [peripheral] euro-zone bonds,” but are turning away from the euro zone in general (read Hungarian Crisis Crushes The Austria ETF).
With this backdrop, yields have moved sharply off of their 52 week low for 10 year German government debt as payouts are now in the range of 1.95%, far higher than the 1.58% low they saw in the middle of November. As a result of the increase in yield volatility, despite the still solid financial position of the central European nation, German bond investing has become more popular in the U.S. However, buying up securities has been, at least until very recently, difficult for the average investor to do both cheaply and easily. Yet, recent developments in the ETF world have broken down these barriers and now allow investors to gain broad exposure to this increasingly important slice of the market. Below, we highlight two great options for investors who are looking to make a play on the German bond market:
The original fund in the space, BUNL looks to provide investors exposure to the U.S. dollar value of the returns of a German bond futures index, replicating the performance of a long position in Euro-Bund Futures. The underlying assets of this contract are Federal Republic of Germany-government issued debt securities with a remaining time until maturity of at least eight years and six months but not more than 10 years and six months (read Top 3 Highest Yielding ETFs).
However, investors should note that this product is an ETN, and as such, doesn’t actually hold German bunds. Instead, it is a senior unsecured debt obligation of Deutsche Bank in which the institution promises to pay out to investors a return equal to the index. While this eliminates tracking error and allows for a collateralized purchase of U.S. Treasury bonds—which can theoretically juice the return of the product—it does also result in credit risk for the investor that holds the product. Nevertheless, BUNL has returned to investors 12.7% since inception, far higher than both the S&P 500 and the Barclays Capital U.S. Aggregate Index in the same time period. These outsized gains have more than made up for the relatively pricey fee of 50 basis points a year and could make this product a solid choice for investors seeking bund exposure (also read Top 3 Highest Yielding Muni Bond ETFs).
For investors seeking a broader play on the German bond market, the brand new BUND could be the way to go. This fund from bond giant PIMCO follows, before fees and expenses, the BofA Merrill Lynch Diversified Germany Bond Index which encompasses euro-denominated investment grade bonds issued by German entities, including sovereign, quasi-government, corporate, securitized and collateralized debt. In the top ten holdings, there is a nice mix of corporate and Treasury securities with bonds from Land Nordrhein-Westfalen taking the top spot followed by Federal Republic bonds in the next two spots.
In terms of expenses, BUND is also on the high side, at least compared to more diversified bond products with an expense ratio of 0.45%. Furthermore, since the product is so new—having debuted on the 9th of November—the volume really isn’t there yet as daily trading is only in the neighborhood of about 3,200 shares. Nevertheless, for investors seeking broad exposure to the German bond market, both in terms of corporate and treasury securities, BUND remains the only diversified choice at this time.
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