Bond ETFs Hold Up Amid Volatility

Chidem Kurdas

Recent big ups and downs in markets, accompanied by increased trading, demonstrated a major advantage of the exchange traded fund format. People sold ETF shares in the secondary market while fund providers were largely free of pressure to redeem shares.  Therefore there was no push to sell the underlying assets.

As a result, the illiquidity of fixed income markets did not become a threat to bond ETF shares and prices in those markets were not affected as they would’ve been in the face of a large-scale rush by funds to liquidate.

ETFs held up better than expected, according to Ryan Szakacs, vice president at BlackRock capital markets. Last week as volatility spiked there were very few redemptions from fixed income ETFs that required going to the primary market, he said at a Capital Link conference on October 23.

The fact that in turbulent markets ETF shares changed hands without involving the underlying baskets of bonds shows that even under market stress ETFs can get around the problem of fixed income illiquidity.

ETFs appeal to a range of investors, including retail customers looking for cheap and easy stock or bond exposure. Hedge funds use ETFs extensively as low-cost instruments for trading, somewhat like futures. This has long been the case with equity ETFs but bond ETFs are also becoming popular for trading.

Large investors use ETFs for various purposes. Increasingly ETFs are in the core portfolios of institutions, says Bill Miller, director of iShares institutional sales. Some 80% of trading in ETFs is by institutions.

High frequency traders have a role. They create more liquidity in exchanges, which is a plus for ETFs, says Mr. Miller. IShares, the world’s largest ETF provider, is part of BlackRock.

Bonds have become more difficult to sell because of regulatory restrictions on bank trading and balance sheets. The Dodd-Frank Act and other financial regulations thinned out the market by forcing banks to shut down trading desks and reduce balance sheet risk.

Financial industry people have been talking for several years about the potential effects of this, especially greater volatility—as I reported here in 2012 and earlier.

In the past few months the subject appeared in the mainstream media.

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