Participants in the high-yield bond market are once again fretting about liquidity as the Federal Reserve inches closer to raising interest rates. With the Fed likely on course to raise interest rates before the end of 2015, investors are once again questioning the ability of junk bond ETFs to endure a potential sequel to the taper tantrum of 2013.
However, liquidity-starved junk bond traders are increasingly turning to ETFs, such as the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK), as it becomes harder – and pricier – to trade junk-rated debt.
“The growing size of trades in the funds tells the same story: Transactions of more than $1 million are making up about a quarter of volumes in the two biggest high-yield ETFs now, up from 15 percent in early 2012, according to a July 10 Deutsche Bank report,” reports Lisa Abramowicz for Bloomberg.
HYG and JNK are the two largest high-yield bond ETFs by assets. The average trailing 90-day volume for the two ETFs is nearly 7.2 million shares compared to just under three million shares per day for the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD), the largest investment-grade corporate bond ETF. Due to new regulations and capital requirements imposed following the financial crisis, these same banks could be forced to cut inventories as well. [Fixed-Income Traders Increasingly Rely on Junk Bond ETFs]
As investors found it more difficult to price fixed-income securities, many have turned to ETFs for their greater perceived liquidity. The potential problems ahead are associated with large redemptions in the ETFs or secondary markets. If enough people exit the funds, the ETF providers will have to swap shares for bond securities in the primary market. However, if there is not enough bond securities in the underlying market to meet redemptions, ETF investors may not be getting what they bargained for. [How ETFs Are Traded]
Speaking broadly of fixed income ETFs, BlackRock (NYSE: BLK), the world’s largest asset manager and issuer of HYG, said in a recent whitepaper, “Bond ETFs offer many of the benefits bond market reformers have long urged: they improve the ability of all investors to transact efficiently, with complete price transparency, and at lower transaction costs. Because bond ETFs trade on an exchange, they show investors what’s really going on, which is especially important when markets are stressed.”
“ETFs have been increasingly providing institutions with a safety valve to get out of investments quickly. These days, big bond buyers are willing to fork over cash for that,” according to Bloomberg.
Year-to-date, investors have pulled $797.6 million from HYG while adding $539.4 million to JNK. LQD has added over $2.4 billion in new assets.
iShares iBoxx $ High Yield Corporate Bond ETF
Tom Lydon’s clients own shares of HYG, JNK and LQD.