Bond ETFs are growing increasingly important as an easy-to-use investment vehicle to help fixed-income investors access a number of various bond markets. However, with any new tool, investors will have to adapt and become acquainted with the instrument to efficiently put it to use.
“We see bond ETFs as important additions to the fixed income investment toolkit. Bond ETFs existed during the 2007-08 global financial crisis and we expect them to trade through stressful environments again in the future. We see bond ETFs as enhancing market liquidity, not detracting from liquidity the way some commentators contend. But we also think investors must understand trading practices and important tradeoffs between strategies in rapidly evolving fixed income markets,” Steve Sachs, Head of Capital Markets at GSAM, and Jason Singer, Managing Director at GSAM, said in a research note.
Investors should evaluates the role and impact of ETFs in a changing bond liquidity landscape and note the implications of these trends to make their best implementation choices.
Given the current concerns over volatility in fixed-income markets and potential liquidity concerns in case of a mass exodus from these assets, Goldman Sachs Asset Management has outlined a number of best practices for investors to consider in today’s changed fixed-income landscape.
For starters, investors should understand trading costs.
“Trading costs in certain fixed income markets can be significant even when they are not immediately visible,” Sachs and Singer said.
For example, ETF shares trade at premiums or discounts to net asset value (NAV, or the underlying portfolio value), depending on market conditions. In stressed fixed income markets, sellers should expect to see ETF shares trade at discounts to NAV. Goldman Sachs Asset Management views fair value – meaning the deviation from NAV – as more important than bid/ask spreads. Additionally, with ETFs, investors will also have to watch for the bid/ask spread – the difference between the price at which market participants are willing to buy a security at a given moment (the “bid”), versus what participants wishing to sell are willing to accept (the “ask”).