Fixed-income traders are increasingly utilizing junk bond exchange traded funds to play the markets in times of rising volatility.
According to Fitch Ratings data, trading activity in junk or high-yield bond ETFs jumped during the 2013 “taper tantrum,” along with short bursts of volatility in January, July and then in September and October this year, the Financial Times reports.
The trend reveals that investors could be using ETFs as a more liquid alternative to the so-called cash market, which has been notoriously known for its illiquid nature.
“It appears there’s some migration of trading to high-yield ETFs and that may be a commentary on the underlying liquidity conditions of the high-yield market,” Robert Grossman, managing director of Fitch’s macro credit research, said in the article.
For instance, over the past week, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) saw $201.1 million in new inflows while the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) added $1.5 million, according to ETF.com data. [Bargain Hunters Snatch Up High-Yield Bonds, ETFs]
According to Trace data, volume in junk bonds jumped to $8.6 billion on October 15, compared to the daily average for the year of $5.6 billion. HYG activity touched $1 billion on the same day, compared to its average $5.6 million.
“There’s so much volume in the ETFs now that certainly the ETF is trading at a better valuation than the underlying,”Eric Lichtenstein, part of the ETF market-making team at Cantor Fitzgerald, said in the article. “The ETF was giving you a real-time view as to where the fixed income market was going,
Nevertheless, an ETF’s true liquidity is limited to the activity of its underlying market. In this case, fixed-income observers are concerned that the low liquidity in the junk debt market could cause problems in junk ETFs if a large sell-off were to occur.
“To the extent that there’s selling of high-yield ETFs that results in redemptions, that could put pressure on the underlying market,” Grossman added. “We didn’t see it in the most recent period [of market stress]but that’s something that remains a concern.”
HYG and JNK increased 1.3% over the past week. Both ETFs were showing above average trading volumes Monday.
For more information on speculative-grade debt, visit our junk bonds category.
Max Chen contributed to this article.
Full disclosure: Tom Lydon’s clients own shares of HYG, JNK.