|How Liquid Are High-Yield Bond ETFs?|
|June 08, 2012-|
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On a longer-term view, last month’s US$1.3 billion net outflow from high-yield bond ETFs looks like nothing more than a blip.
Fixed income trackers are currently the fastest-growing sector of the ETF market and, within that category, high-yield (or “junk bond”) funds have recently attracted the greatest interest. The two largest US-listed funds of this type, iShares’ iBoxx $ High Yield Corporate Bond ETF (NYSE Arca: HYG) and State Street’s SPDR Barclays Capital High Yield Bond ETF (NYSE Arca: JNK) have added around US$10 billion in new assets since October, taking their combined size to nearly US$25 billion.
High-yield ETFs now constitute around 3 percent of the overall junk bond market and generate around 10 percent of the daily trading volume in such bonds, one market observer told IndexUniverse.eu.
ETF evangelists talk of the transformational role being played by such funds in what is traditionally a relatively illiquid sector of the market.
“We’re bringing a revolution to the high-yield bond market by increasing liquidity and pricing transparency,” a senior executive at one ETF issuer told IndexUniverse.eu last month.
But not everyone is convinced of this argument. Dan Fuss, vice chairman of US firm Loomis Sayles and a widely followed bond fund manager, warned last year in FTFM that “the liquidity function of high yield stinks” and that investors needing to sell high-yield ETFs in a hurry could face “haircuts” of up to 10 percent, with funds trading at a substantial discount to net asset value.
And, in a sign that investors’ recent charge into income-producing funds is concerning other asset managers, Vanguard announced two weeks ago that it is closing its US$17 billion high-yield corporate bond fund to new clients, citing “potential liquidity challenges” as a concern.
“In this prolonged low-rate environment, we continue to see investors turn to high-yielding alternatives...and we’ve cautioned investors accordingly about reaching for yield,” says Vanguard’s CEO, Bill McNabb.
On the face of it, publicly available data support ETF managers’ contention that their funds can offer superior liquidity to the underlying bond markets.
iShares’ flagship European high-yield bond ETF, the €1 billion Markit iBoxx Euro High Yield Bond fund (LSE: IHYG), has traded on its primary (London) listing with an average bid-offer spread of 31 basis points since the fund’s inception in September 2010. By comparison, the weighted average bid-offer spread on the constituent bonds of the ETF’s underlying benchmark, the Markit iBoxx Euro High Yield index, has averaged over three times more during the same period, at 95 basis points.
Trading Costs For IHYG And Its Underlying Index
Source: London Stock Exchange Weekly ETP Statistics (no spreads were calculated between February and May 2011); Markit
The comparison between the ETF and the index is not entirely like-for-like: the London Stock Exchange’s weekly bid-offer spread calculation for IHYG is time-weighted and uses all available “tick” data from the exchange’s continuous trading session, while Markit’s monthly index spread calculation is based on a single daily snapshot (taken at 4.15pm, towards the end of each trading day). But on the basis of these two measures of liquidity, the ETF has traded since its 2010 launch with bid-offer spreads that are consistently lower than those on the portfolio of bonds constituting the index.
It’s noticeable that in early August 2011 the ETF and index spreads temporarily converged. During the week of August 8-12, both ETF and index fell by 4 percent in price, as increasing tensions in the eurozone had a knock-on effect on the corporate credit markets.
Apart from that single week, however, the ETF’s spreads have been tighter than those of the index, with the divergence increasing over time. The index’s spread has retreated from the 140 basis point level recorded in October and November last year but has not returned to the 60-70 basis point spreads seen during the first few months of 2011, and remains above 1 percent. But in February and March this year, IHYG’s spreads did retrace to the 15-20 basis point lows of late 2010/early 2011.
One reason for this divergence may be the accelerating inflows into high-yield bond ETFs since late last year, which have led to many more market makers quoting prices in these funds, in turn keeping spreads tight. Indeed, from late September 2011 to the end of April 2012 IHYG experienced only positive weekly net cash flows, with the fund’s net assets more than doubling during the seven-month period.