As banks and institutions hoard fixed-income securities, investors have turned to bond exchange traded funds in response to the lack of liquidity across the underlying markets, potentially setting the stage for liquidity problems if ETFs experience large redemptions.

For instance, the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD) has attracted $2.2 billion in new inflows year-to-date, Vanguard Intermediate-Term Corporate Bond ETF (NYSEArca: VCIT) brought in $358.3 million, SPDR Barclays Intermediate Term Corporate Bond ETF (NYSEArca: ITR) added $34.3 million and PIMCO Investment Grade Corporate Bond Index ETF (NYSEArca: CORP) saw $99.4 million in inflows, according to ETF.com data.

Now, Barclays analysts led by Jeffrey Meli warned of a potential “fire sale” risk in ETFs and bond funds, notably those that track illiquid assets like corporate bonds, after large traders poured into bonds as rates fell and regulators forced financial institutions to obviate another 2008 crisis by holding more quality assets, reports Tracy Alloway for the Financial Times. [Rate Risk Raises Liquidity Concerns in Junk Bond ETFs]

“Regulations aimed at bolstering stability at the core of the financial system, combined with a growing demand for liquidity, may eventually lead to increased instability and fire-sale risk in the periphery,” Barclays analyst said.

As investors found it more difficult to price fixed-income securities, many have turned to ETFs for their greater perceived liquidity. For instance, LQD, with $21.9 billion in assets, has an average daily volume of 1.7 million shares. Taxable bond funds have attracted $1.2 trillion in inflows since 2009, and credit ETFs now make up 2.5% of the investment-grade corporate debt market.

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