Bond ETFs Can't Shake Off Liquidity Concerns

The quickening growth of bond exchange traded funds has drawn an increasing amount of concern over potential liquidity issues in the event of a sustained rise in yields.

Bond investors have turned to fixed-income ETFs that provide a relatively seamless way to gain exposure to the underlying debt markets, but critics argue that the funds have not be tested by a significant fixed income shock, such as mass redemptions in response to rising rates, the Financial Times reports.

A number of high profile investors, like Carl Icahn, have warned of the potential risks in bond ETFs, outlining fears that if debt prices suddenly plunge, investors may rapidly sell off ETFs, which could trigger a cycle of sell-offs and falling prices.

“I think it is very very dangerous to assume you can turn an illiquid market into a liquid market,” Gershon Distenfeld, director of high yield at AllianceBernstein, told the Financial Times.

Critics have grown louder in light of the bond ETF industry’s recent success. According to ETFGI, global fixed-income ETFs held over $600 billion in net assets under management as of the end of July 2006, compared to $60 billion at the end of 2007. Inflows into fixed income ETFs have outpaced equity ETFs this year, with bond ETFs bringing in $83 billion compared to $62 billion for stock ETFs.

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