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Bond ETFs and Illiquid Markets

ETFtrends.com

As interest rates tick higher, some market observers are voicing fears over bond-related exchange traded funds’ ability to meet large redemptions. Fund providers, though, argue that concerns have been overblown and ETFs are acting as they should.

Last month, Citigroup, an authorized participant that helps create and redeem ETF shares, suspended redemptions on some ETFs, stoking liquidity concerns over the bond ETF market, Investors Chronicle reports. [Digging Deeper Into Bond ETF Pricing, Liquidity]

However, some have pointed out that Citigroup still allowed investors to trade small numbers of shares through their brokers, and Citigroup is only one of many authorized participants. Consequently, BlockRock’s iShares contends that ETFs are doing what they are supposed to and investors can still get out if they want.

“When ETFs work well, they can actually be more liquid than the investments they follow – they often have an advantage over actively managed products,” Adam Laird, passive investment manager at Hargreaves Lansdown, said in the article. “Whenever there are liquidity problems, it often hits all products across the board and there are examples in other asset classes where actively managed funds have been affected worse by liquidity issues than ETFs. If you want a passive exposure to bonds, ETFs are still an efficient way to get it.”

When a situation calls for a large redemption, the manager is up against time constraints to sell enough bonds to meet the redemption. If the manager can’t meet the sell, then redemptions are temporarily suspended. However, investors should know that since ETFs are traded on an exchange, investors would likely face a widening bid/ask spread instead any suspensions.

Moreover, bonds ETFs can trade at a premium or discount to their net asset value. For instance, corporate debt ETFs were trading at a premium during the second half last year as investors were rushing into yield-generating assets but began trading at a discount this year as interest rates increased. Peter Sleep, senior portfolio manager at Seven Investment Management, points out that an unlucky investor could have bought at a maximum premium and sold at a maximum discount, incurring an even steeper loss.

Sleep, though, also notes that high-yield bond ETFs were trading at a slight discount during the height of the recent selloff.

“It proves the point that ETFs are helping to make an illiquid market more liquid,” Sleep said.

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

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.