Corporate Bond ETFs Reflect Growing Unease in Credit Market

A popular investment-grade corporate bond exchange traded fund reflects growing concerns among investors as demand for protective hedges increases and its sticker prices dips below its net asset value.

The iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) has seen open interest on bearish put options rise to a record in recent sessions, Bloomberg reports. Additionally, LQD closed at a discount of 0.6% to its net asset value earlier in the week, reflecting the largest discount to its NAV since the pandemic market chaos that triggered widespread selling in the credit markets.

A widening disparity between an ETF’s price and the value of its underlying assets typically indicate rising risk aversion across underlying securities. For example, when the Covid=19 pandemic struck the markets, liquidity in the bond market disappeared as traders were reluctant to buy, but ETFs kept on trading in the secondary markets, which contributed to a historic dislocation between the two markets.

The current ETF discount is attributed to the volatility associated with the Russia-Ukraine war, with commodity prices surging and fueling fears of stagflation or slow growth and high inflation for Corporate America.

Meanwhile, the popular iShares iBoxx $ Investment Grade Corporate Bond ETF has declined 8% year-to-date and is trading around its lowest level since April 2020. ETF investors are also dumping the play in droves. LQD was among the most hated ETF plays in the past week, experiencing $1.5 billion in outflows, according to ETFdb data. Additionally, according to Bloomberg data, LQD showed one of the highest put-to-call ratios based on options trading volumes as of March 7.

“Investors are more negative about credit quality” as the impact of the invasion of Ukraine becomes more appreciated, Todd Rosenbluth, head of ETF and mutual fund research at CFRA, told Bloomberg. The price dislocation and hedging are signs they’re “preparing for more of a risk-off environment.”

The price dislocation in iShares iBoxx $ Investment Grade Corporate Bond ETF is not an isolated event as it is only one example of a wider trend across the bond market. Around 60% of bond ETFs are now trading at a discount to their NAV, the highest level since March 2020 and double the long-term average of 28%, according to Bloomberg Intelligence.

For more information on the fixed-income market, visit our bond ETFs category.