ETF NEWS - ULTUMUS

Increasing Interest

Written by Bernie Thurston | 28 June 2023

Capitalising on Higher Interest Rates

Positive Returns driven by Higher Interest Rates.

Money market Euro denominated ETFs had consistently small negative returns between 2015 and 2021, before flatlining in 2022. Now in 2023 they are starting to produce positive returns as interest rates rise.

 

Even when rates were negative, these products attracted significant assets of hundreds of millions or billions, because bank deposits in the Eurozone often charged an even larger negative interest rate. That differential remains the same now: because most people are more likely to get divorced than change their bank account, the banks rely on the inertia factor and pay well below market interest rates.

 

These are very transparent products, based on indices that are in turn based on €STR (ESTER), which is published by the European Central Bank. On June 28, 2023 the rate was 3.397%, annualised. This is likely to increase further: ECB Governor, Christine Lagarde, has indicated further rate rises in July.

 

One product, DWS Xtrackers II EUR Overnight Rate Swap UCITS ETF, tracks Euro short term interest rates, based on the Deutsche Bank Euro Overnight Rate Total Return Index, and capitalises the interest, rolling it up inside the ETF.

 

This index is based on the Euro short-term rate, (€STR) or ESTER, plus 8.5 basis points or 0.085%. A similar index, Solactive Euro Overnight Return Index, is used for Lyxor Euro Overnight Return UCITS ETF.

 

ESTER has now superseded EONIA (Euro OverNight Interest Average) interest rate, after the working group on euro risk-free rates decided on this new interest rate benchmark.

These are generally perceived as low risk. UCITS products are ranked from on a Synthetic Risk and Reward Indicator (SRRI), with 1 being the lowest and 7 the highest risk. These ETFs are ranked as 1.

 

A money market ETF could appeal to investors who do not want to take on the interest rate duration risk that comes from some fixed income products. Supposedly safe investment grade bonds in 2022 lost several percent, because fixed income bond prices move in the opposite direction of interest rates.

 

The DWS and Lyxor products both have an all in fee of 0.10%. Both products are tracking their benchmarks tightly.