You may have noticed an interesting news story a couple weeks back about Apple selling a record $17bn in bonds – the largest corporate bond deal in history. While the deal didn’t have much to do with ETFs per se, you can bet that whenever the words “record” and “bonds” are being tossed around together, my phone is probably going to ring. For the most part, investors just want to understand if and how this new offering will be included in their ETF holdings.
It’s a great question, and one we like to revisit every so often since it’s not the most intuitive process. If you’re wondering whether these new Apple bonds will end up in your fixed income ETF, you first need to look at the index your ETF tracks. Bond indexes have rules that determine which securities should be included, things like maturity range, credit rating and issue size (these rules can usually be found on the index provider’s website and the ETF’s prospectus). And since the bond market is constantly in flux, with new issues entering the market all the time, most bond indexes rebalance on a monthly basis – typically on the last day of the month. During the rebalance, the provider applies their specific rules to the overall market and all the securities that qualify are included in the index. This is one of the nice things about most bond indexes – the constituent selection process is rules-driven, which gives investors a clear understanding of what is included in an index and why.
In the case of the Apple bonds, the issues that came to market were large and high quality, ensuring that they would be included in most of the investment grade corporate bond indexes. For example, they qualified for indexes like the Barclays Capital Credit Index and the Markit iBoxx USD Liquid Investment Grade Index. Markit, Barclays and most other providers fix the constituents of their indexes a few days before the end of the month, so the April 30th Apple issuance won’t actually enter these indexes until the end of May.
Of course, unlike the indexes, ETFs can’t all add the new Apple bonds on the last day of the month. Liquidity may not be available, and it may not make sense to try to make all of the purchases at one time. Instead, funds will generally “leg into” a new issue, especially one as large as the Apple issuance. In fact, if you take a look at the iShares Investment Grade Corporate Bond ETF, or LQD (which tracks the Markit Index referenced above), you will see that the fund has already begun to acquire Apple bonds (see current holdings here). We can expect that by the end of the month, the fund will likely have increased its position, with the goal of having an exposure similar to that of the index.
Once the bonds go into the index and subsequently are included in relevant ETFs, you’d expect them to stay in there until they mature, or are called (if they have a call option), or stop meeting the index’s requirements (for example, fall below the minimum credit rating). At that point, the process for removing a bond from an index and ETF is much the same as it is for inclusion, just in the opposite direction. The bond would be kicked out of the index at the next rebalance, and sold out of the ETF on or around that date.
Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy.