Fears about bond ETF illiquidity deepened after the COVID-19 crisis based on the widening discounts between corporate bond ETFs and NAV pricing, but the surge in ETF trading volumes suggested bond ETF liquidity held up well and that ETF trading spreads widened far less than underlying cash bonds.
In this paper, we examine:
- The COVID-19 related sell-off in corporate bonds in the first quarter 2020 that caused some commentators to express concern about the liquidity and functionality of fixed income ETFs, led by corporate bond ETFs.
- Widening discounts between corporate bond ETFs and NAV pricing after COVID-19 was cited as further evidence of ETF illiquidity. But ETF NAVs use estimated prices for underlying cash bonds, not market trades, and may become stale quickly. In contrast, ETFs trade on exchange daily, and rapidly move to new equilibrium pricing, in the face of a shock, like COVID-19. This makes ETF pricing timelier than NAV calculations, as the Bank of England pointed out.
- Scant evidence that the liquidity infrastructure around ETFs, driven by authorized participants, failed during the March/April 2020 period—trading spreads were much narrower in fixed income ETFs than the underlying bonds.