By Robin Marshall, director, fixed income research
Fears about the liquidity of bond markets have kept investors and regulators awake at night since the freezing of credit markets signalled the start of the Great Financial Crisis.
In recent years, this disquiet has extended to fixed income Exchange Traded Funds (ETFs), particularly corporate bond ETFs, because fixed income ETF’s AUM grew from around $25bn1 just before the crisis, to $1tn1 in 2019, without ever being tested by a major market shock.
In the early days of the Covid-19 shock in the first quarter of 2020, the sell-off in corporate bonds (see Chart 1) caused some to express deeper concern about the liquidity and functionality of corporate bond ETFs.
Chart 1: Investment Grade and corporate bond yields in 2020
Source: FTSE Russell, data as at September 25, 2020. Past performance is no guarantee to future results. See end for important disclosures.
The crux of the argument was that corporate bond ETFs are built from corporate cash bonds, which trade over-the-counter (OTC), in a fragmented market, with severely diminished liquidity since the GFC. In the event of a credit event, or market shock, such as Covid-19, ETFs would become un-tradeable with no “liquidity.” Fears were also expressed that a widening discount between ETF pricing and NAV would emerge.
But our analysis shows the liquidity of corporate bond ETFs remained resilient in the COVID-19 shock. In fact, we found that the ETFs in question remained more liquid, and easier to effectively value, than the underlying assets, helped by the supporting infrastructure and exchange trading.
Read the paper for our explanation of why fixed income ETF trading spreads widened far less than underlying cash bonds, and why ETF pricing may be a better guide to new equilibrium pricing than a stale NAV.
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- Source: BlackRock GBI, as of June 2019.
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