Exchange-traded bond funds are proving an integral part of today’s financial architecture
By Jon Sindreu
The NYSE closed temporarily for the first time as a result of coronavirus concerns on Tuesday. ETF prices have become “the effective benchmark prices of the underlying market,” according to analysts at French bank Société Générale. / Photo: Kearney Ferguson/Associated Press .
What doesn’t kill a useful financial instrument will probably make it stronger.
During both the coronavirus selloff and this week’s bounce, big gaps have opened up between the value of exchange-traded bond funds and that of their holdings.
Over the past two weeks, the iShares iBoxx $ Investment Grade Corporate Bond ETF—the largest of its type—has traded at both its largest discount and its largest premium to net asset value in 11 years.
ETFs have long been a popular way for investors to track equity indexes, but over the past decade they have come to dominate bond markets too. Many professional investors, however, suspect them of posing a 2008-style systemic risk—fears to which signs of stress lend weight.
The issue, they argue, is that ETF shares are easy to trade in good times, obscuring the fact that many of the corporate bonds held—particularly those rated below investment grade—become hard to sell in bad times.
This illiquidity can then spread to the ETFs, which are passive vehicles that can’t remove problematic issues from their baskets. As investors rush to sell their ETF shares, the pain could infect even resilient bonds.
Furthermore, middlemen may find it hard to buy and cancel shares—which is how ETF liquidity is ultimately backstopped—because doing so would involve absorbing illiquid bonds that would be prohibitively expensive to hedge.
So far, though, this nightmare contagion scenario hasn’t played out, despite extreme market moves. While the iShares ETF and its sister junk-bond product recently experienced their largest outflows on record, activity in the “primary” market—where banks create and destroy shares—hasn’t been abnormally elevated relative to the high turnover of the ETFs’ shares on stock exchanges. ETFs have essentially been able to rely on their own liquidity, rather than that of the underlying bonds.
This is fundamentally different from 2008 when investors abandoned complex credit derivatives even as some of the underlying mortgage-backed securities pared the blow. In this case, ETF prices have become “the effective benchmark prices of the underlying market,” analysts at French bank Société Généralepoint out. Bond prices may need to catch up, but this doesn’t mean something is fundamentally broken.
Some ETF prices may now be more “real” than the markets they track—a reversal that should interest the philosophically inclined. This isn’t unlike how oil futures contracts have superseded actual spot transactions as a way to measure the price of crude.
In today’s globalized, highly complex financial markets, top-down macroeconomic information may simply be more relevant than bottom-up facts. During the coronavirus selloff in particular, traders have often been clueless about the worth of individual issues, while still having strong views about the economic shock. They have expressed them primarily through ETFs, but also through index-based credit-default swaps—another way to bet on the broader corporate-bond market.
Investors should still avoid complex, poorly designed ETFs, like the inverse-volatility ones that imploded in 2018, or those that track assets too illiquid to have a reasonable price. But the fact that even junk-bond ETFs are functioning properly suggests that the threshold is higher than some feared.
For those still doubtful, the U.S. Federal Reserve’s announcement this week that it would buy shares in investment-grade corporate-bond ETFs as part of its stimulus policies—even though it is also directly buying the underlying bonds—sends an “all clear” signal. This is a piece of financial engineering that has become too useful to fail.
0 comments:
Publicar un comentario