The big shift of investor cash to passive funds from active ones has gotten a lot of bond investors nervous about liquidity.
Unlike stocks, bonds are much more limited in number. That means that the bonds comprising an exchange-traded fund–which is effectively a big basket of bonds–aren’t exactly reflective of the bonds that can actually be bought and sold at any single point during the trading day.
This can become problematic if a bunch of investors suddenly want to sell, particularly in the less-liquid world of junk bonds, and can create a gap between the value of the bond ETF and its net asset value. Jared Dillian explains the possible consequences in a BloombergView column Tuesday:
“The high-yield debt market, by and large, is still a voice market in that trading is done over the phone. If the market “crashes,” with or without an exogenous event, my guess is that there is the potential for a high-yield bond ETF to trade at a 5 percent to 10 percent discount to its NAV. Through arbitrage, the underlying bonds will eventually “catch up” with the ETF, but it may take several hours, or longer, but we don’t really know. Yes, these ETFs were around during the financial crisis of the last decade, but they had a fraction of the assets — and trading volume — that they do today. They are untested.”
Yet Mr. Dillian is quick to dismiss worries that using a liquid vehicle to sell an illiquid asset class will trigger volatility. Rather, the “ETF then becomes a form a price discovery, where the price of the ETF is the best guess of where the bond market will open once it begins trading.” He writes:
“Think of what the high-yield world would look like in a crisis without the ETF: nothing trades and people watch helplessly as positions are relentlessly marked lower. That sounds a lot worse than panicking and selling the ETF when its price gaps below its NAV only to see it recover if the dislocation turns out to be of no consequence.”
True, market innovation and technology have given retail investors access to assets that were effectively off-limits decades ago, from bonds in Poland to stocks in Peru. “If technology and innovation are good when it comes to, say, Amazon.com, they are also good for your brokerage account,” Mr. Dillian writes. Still, investors should know full well that bond ETFs are not cash, particularly as they enter into less liquid corners of the market.
hi!,I like your writing so much! share we communicate more about your article on AOL? I require a specialist on this area to solve my problem. Maybe that’s you! Looking forward to see you.
I’ll immediately grasp your rss as I can not to find your e-mail subscription hyperlink or newsletter service.
Do you’ve any? Kindly allow me realize in order
that I may subscribe. Thanks.
We are a bond tracking service. You can visit http://www.bondevalue.com and subscribe to the app. The first month is free. If you wish then you can continue with the subscription after the first month on a paid plan. Even if you do not wish to continue, we will send you the newsletter on your email for free even after your free subscription is over.
I get pleasure from, cause I discovered exactly what I was having a look for. You have ended my four day lengthy hunt! God Bless you man. Have a great day. Bye|
Thank you very much