With the advent of exchange traded funds, securing exposure to the fixed-income markets has become easier than ever.
“Electronic trading venues, open to the whole bond market, are gaining ground,” Mark Wiedman, global head of iShares and index investments at BlackRock, and Richie Prager, global head of trading, liquidity and investments platform at BlackRock, wrote on the Financial Times. “And bond ETFs are likely to keep growing as a liquid, efficient way to trade and invest in standardised bundles of bond risk, especially under stress.”
It has now become harder and costlier to trade in debt securities, especially since the crisis after regulators squeezed out investment banks with tighter capital, liquidity and conduct rules. The more stringent regulatory requirements have diminished banks’ balance sheets and their ability to pay dealers or so-called middlemen in the primary bond markets.
Prior to the financial crisis, global banks held almost $250 billion in bond inventory, but now, they hold less than $50 billion. On the other hand, the U.S. corporate debt market has distended to almost $6 trillion from $2 trillion.
“As the bond market talks about electronic trading on platforms one day, the bond ETF is making it happen on exchanges today,” Wiedman and Prager said. “ETFs have become the easiest way for US and European investors to trade bond risk without a middleman. The bond ETF is adding liquidity, sharpening price discovery, and reducing pressure on banks’ balance sheets, especially under stress.”
Fixed-income traders are now trading directly with other investors on an equity exchange through bond-related ETFs, a “transformational concept in the bond markets,” according to the strategists.
Specifically, the advent of ETFs has helped bond investors to efficiently price and gain bond exposure as opposed to diving directly into the notoriously illiquid underlying markets. For instance, it costs about 50 basis points to acquire a bunch of high-yield debt in the U.S., whereas it costs 1 basis point in spread for the same exposure in a liquid, high-yield ETF. For the Eurozone market, high-yield bonds cost 60 to 70bps, compared to the 13bp spread for an ETF.
Trading volume also reveals the rising preference for ETFs. High-yield bond ETFs traded on an exchange average show volumes of about $3 billion per day, compared to the $9 billion in the underlying cash market and $6 billion for index credit derivatives.
For more information on the fixed-income market, visit our bond ETFs category.