Exchange traded fund providers are securing bank credit lines to quickly provide cash for large redemptions in response to the growing liquidity concerns.
The Vanguard Group, Guggenheim Investments and First Trust are among U.S. ETF companies that have expanded their bank guarantees to access more cash, Reuters reports.
For instance, First Trust raised its credit line to $80 million at the end of last year, the most recent reporting period, from $20 million in early 2013. The line is shared by two of its ETFs and two mutual funds with $645 million in assets under management. Vanguard engaged its first committed bank line of credit last year and now has access to $2.89 billion from multiple banks. State Street and Invesco PowerShares have opened credit lines for their respective senior loan ETFs.
“You want to have measures in place in case there are high volumes of redemption so you can meet those redemptions without severely impacting the liquidity of the underlying securities,” Ryan Issakainen, exchange-traded fund strategist at First Trust, said in the Reuters article.
The ETF industry is taking preventative measures as the Federal Reserve and U.S. regulators express concern about fund providers’ ability to meet mass investor redemptions in case of another financial crisis. Specifically, many are looking at fixed-income ETFs, which track less liquid debt markets, such as speculative-grade corporate debt and senior bank loans. [Liquidity Concerns in Corporate Bond ETFs]
“These funds offer daily or even intraday liquidity to investors while holding assets that are hard to sell immediately, thus making the funds vulnerable to liquidity risk,” U.S. Federal Reserve Vice Chair Stanley Fischer previously stated, pointing to ETFs and pointing out that the investment tool has quickly expanded in size while tracking indices of “relatively illiquid” assets.
Due to the Dodd-Frank reforms, banks have been hoarding bonds to meet regulatory requirements, which has diminished the number of debt securities floating around in the markets. Consequently, many are now concerned that a major bond market sell-off could exacerbate the effect of the liquidity mismatch in fixed-income ETFs.
ETFs create and redeem shares by swapping for a basket of underlying securities. In case of heavy redemptions, the ETF provider would need to sell shares of the underlying securities in the fund to meet the redemptions. However, if the underlying market is illiquid, the ETF provider may be forced to dump securities at any price, which could cause the share prices to rapidly decline. [How ETFs Are Traded]
With a credit line in place, fund providers can quickly payoff the redemptions without resorting to dumping the underlying securities.
However, ETF investors should note that these credit lines come at a cost. According to company filings, bank fees could range from 0.06% to 0.15%, which may be tacked on to an ETF’s annual expense ratio.
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Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Mr. Lydon serves as an independent trustee of certain mutual funds and ETFs that are managed by Guggenheim Investments; however, any opinions or forecasts expressed herein are solely those of Mr. Lydon and not those of Guggenheim Funds, Guggenheim Investments, Guggenheim Specialized Products, LLC or any of their affiliates. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.