As the popularity of fixed-income ETFs rises, bond ETFs have become a go-to way for large investors to move money in and out of debt exposure, sometimes at the expense of the underlying market. However, municipal bond watchers should keep in mind that there has yet to be any significant relationship between the growth of ETFs and muni bond market liquidity.
According to the Chief Economist of the Municipal Securities Rules Board, the self-regulatory organization that oversees the municipal securities market, there is no statistical relationship between ETFs and muni bond market liquidity.
MSRB’s findings were a response to recent academic research into the corporate bond market that identified an inverse relationship between ETF growth and liquidity of the underplaying bonds – as ETFs grew in popularity, liquidity of the underlying bonds deteriorated. Since municipal bond ETFs and the broader bond ETF universe have experienced rapid growth in recent years, Municipal Securities Rulemaking Board set out to explore the nature of the relationship between municipal bond ETFs and the liquidity of the municipal bond secondary market.
“Despite the steady growth of municipal bond ETF assets since 2007, we found no evidence of an impact on municipal market liquidity,” MSRB Chief Economist Simon Wu said in a note. “However, the impact could certainly change over time with the continued growth of municipal bond ETFs, which, even after an explosive decade of growth, still represent less than one percent of all municipal securities-related investments.”
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To put the municipal bond ETF market in perspective, there are 43 munis-related bond ETFs on the market with $30.97 billion in assets under management, according to XTF data. In contrast, there are 340 bond ETFs with $568.8 billion in assets and there are 2,140 U.S.-listed ETFs in the overall market with $3.5 trillion in assets under management. When compared to the broader market, the municipal bond ETF segment still has a long ways to go or at least has a lot more room to run.
“The growth of the municipal bond and other fixed-income ETF markets offers a new tool for investors and market participants, beyond that which can be accessed directly in the over-the-counter bond market. However, it should be noted that the ETF structure itself remains dependent on the liquidity of the underlying bond market,” MSRB said.
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ETFs depend on the liquidity of their underlying markets. If the underlying bond market liquidity becomes impaired, then the innate ETF creation and redemption process could also be strained, making it harder for Authorized Participants or market makers to efficiently create or redeem shares and keep the price of an ETF inline wit its underlying value.
For more information on Fixed Income ETFs, visit the ETF Trends Fixed Income Channel.