The fixed-income market is notoriously known for its less liquid nature relative to equities. However, exchange traded funds have boosted the perceived liquidity of the bond space.
“The growth of the fixed income ETF market has helped to create a new, incremental source of liquidity for investors, above and beyond that which can be accessed directly in the OTC bond market,” according to a recent BlackRock iShares research note. “The ETF effectively provides an additional trading venue—the exchange—where fixed income risk can be transferred among investors. This additional layer of exchange liquidity increases the total amount of liquidity available to fixed income investors.”
BlackRock points out that over the past five years, growing interested in fixed-income assets have helped corporate bond ETFs experience a surge in growth, which has outpaced the growth of primary corporate debt market.
Specifically, from the end of 2007 through the end of 2013, the corporate debt market expanded 81% to $4.7 trillion from $2.6 trillion, while assets in investment- and speculative-grade corporate bond ETFs jumped 25-fold to $100.4 billion from $3.9 billion. The sudden interest in corporate bond ETFs was also accompanied by a 10-fold jump in exchange trading volume over the same period as more investors turned to ETFs.
Consequently, BlackRock contends that the amount of liquidity available through ETFs as a percentage of corporate bond market has steadily increased.
Some market observers, though, have warned that the increased reliance on ETFs could cause more people to come up against liquidity issues once a major sell-off occurs as ETFs try to redeem shares in an illiquid primary market.
“Is there a story to bond ETFs contributing to the problem? No,” Mark Wiedman, head of BlackRock’s iShares ETF unit, told Bloomberg. “They are contributing to the solution, I think we can say that with 100 percent confidence.”
Moreover, ETF providers help provide disclosure of liquidity risks and greater freedom to handle redemptions, including enacting “out of the money gates,” paying back large institutional investors in-kind and using short-term borrowing to meed redemptions.
“Liquidity risk management has been part of portfolio management kind of since the beginning of time,” and investors have already adjusted their behaviors, BlackRock co-founder Barbara Novick said in the Bloomberg article.
Nevertheless, BlackRock is proposing new trading reforms to help assuage bond liquidity concerns, reports Jessica Toonkel for Reuters.
The money manager has outlined a new trading protocol for fixed income securities that would more closely match how equities trade with buy and sell orders when matched up. Additionally, the firm suggests delaying the disclosure of large block trades on fixed-income securities to the end of day or lowering the minimum threshold when they need to be disclosed could help diminish market reaction to the trades.
For more information on the fixed-income market, visit our bond ETFs category.
Max Chen contributed to this article.