This article was originally published on ETFTrends.com.
By Todd Rosenbluth, CFRA
Fixed income ETFs comprise just 1.4% of the overall fixed income market as of June 2018, but there remain persistent liquidity concerns for these funds. This summer, Howard Marks, co-chairman of hedge fund Oaktree Capital, mused about the probability that in a crisis a high-yield bond ETF will not be more liquid than the underlying bonds. Yet, according to Greenwich Associates, diminished liquidity in global bond markets, due in large part to increased bank capital requirements, is fueling demand for fixed income ETFs among institutional investors.
Indeed, ETF allocations have grown to approximately 18% of $28 billion in total fixed-income assets among the 87 institutions Greenwich spoke with, with 80% citing “liquidity/low trading costs” and 78% choosing “easy to use” as reasons for using bond ETFs.
While retail investors tend to focus more on the expense ratio when choosing an ETF, institutional investors look to other factors such as trading volume and bid/ask spreads.
CFRA has research on 63 fixed income ETFs that trade more than 250,000 shares daily and 138 that traded with a bid/ask spread of $0.03 or less as of September 10. Examples of funds that meet both criteria include iShares Core US Aggregate Bond ETF (AGG), SPDR Bloomberg Barclays High Yield Bond (JNK), VanEck Vectors JPMorgan EM Local Currency Bond (EMLC) and Vanguard Short-Term Bond Index ETF (BSV). In rating more than 200 fixed income ETFs, CFRA incorporates a fund’s liquidity and trading costs and combines them with a review of the risk-reward characteristics of the portfolio.
For example, JNK and EMLC are rewarding for the higher yield they provide, but this is offset but elevated credit risk. Meanwhile, BSV incurs less credit and duration risk, but sports a more moderate yield.
Unlike an individual bond, a fixed income ETF trades on an exchange with price transparency. The standardization of the bonds inside the portfolio, based on well-defined criteria, further supports the liquidity benefits. Meanwhile, unlike a fixed income mutual fund, there are no forced redemptions with an ETF and bid/ask spreads have tightened during prior periods of bond market volatility.