Bond ETFs have been trading at notable discounts to their net asset values. CIO and Director of Research for ETF Trends, Dave Nadig, and Todd Rosenbluth of CFRA Research share some ideas on the situation with CNBC’s Bob Pisani during Monday’s ETF Edge.
As Pisani points out, there have been some spreads with these bond ETFs. The question now is what seems to be “broken.” Nadig explains how there may be bonds in certain indexes that have not traded for days or weeks, but they still have to be priced. A net asset needs to be established as a mutual fund or an ETF.
The way to do that for something that has not traded involves establishing some kind of model. That model would ideally look at the last time the bond traded, see how similar things have done, and then adjust the untraded price for a fair estimate. The problem is the lag that leads to outdated information being applied.
“So when you have a hyper liquid market with a hyper volatile movement in price as we’ve seen across the entire fixed income market, those services lag,” Nadig states. “The NAV stays stuck at an artificially high level.”
An Artificial Gap
With an artificial gap, it’s the people buying ETFs who are correct in trusting in the model, while the market being slower is having its own effect on how the data is presented. And as Nadig adds, it may only get worse for the mutual fund industry. It already has outside of the U.S.
Rosenbluth adds to the agreement with all of this, noting how the ETF is more right, while the ETF and mutual fund based on the asset value is not correct because of how quickly things are moving. And as a result, the bond market is not as liquid.
As far as a solution, Nagid explains how time will eventually help everything be resolved naturally. That in mind, people can see the net asset values on these bond ETFs and mutual funds are starting to plummet down to the levels they’re expected to be at. Still, what’s fundamentally broken is the valuation of untraded assets, which is happening at the NAV level in both the ETFs and mutual funds, which can’t be fixed overnight.
To resolve this issue, major structural changes to how credit markets work will need to occur. As it stands, this is all a commentary on the structural arrangement of the bond market, as opposed to the ETF market. The ETF market has managed to be very accurate during all of this, including the estimations of the Chinese market, which was closed for over a week.
Watch Dave Nadig Discuss The Spreads Seen In Bond ETFs:
For more market trends, visit ETF Trends.