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Bond ETFs Can Survive More Volatile Sell-Offs

This article was originally published on ETFTrends.com.

Some observers have warned of liquidity risks in the notoriously illiquid credit debt market and related corporate bond exchange traded funds. However, the ETF risks may be blown out of proportion.

Bank of America Corp. research indicates that high-grade credit continues to enjoy high liquidity, with record redemptions from ETFs of late belying ongoing appetite for company debt among retail and institutional investors, Bloomberg reports.

“For us to be concerned about large overall high-grade outflows – i.e. from bond funds as well - we need to see a much bigger increase in interest rates,” strategists including Hans Mikkelsen and Yunyi Zhang wrote in a recent note to clients.

The iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) , the largest investment-grade corporate bond-related ETF, experienced $921 million in net outflows last Wednesday, the largest daily outflow since its 2002 inception, and followed a record redemption in the prior week.

Fueled by U.S. interest rate concerns, money managers have yanked $14.1 billion from debt funds including ETFs, led by speculative-grade debt, marking the fifth-large stretch of redemptions in the week through February 14.

However, observers concerned about liquidity issues may be blowing things out of proportion in the ETF segment, especially since ETFs hold just 2.9% of outstanding stock of high-grade corporate bonds, with LQD representing 0.5%. Furthermore, BofA found that dedicated corporate bond funds and ETFs have experienced $1 billion in inflows so far this year.

J.P. Morgan Chase & Co. also mirrors the same sentiment, proposing that investors shouldn't be too concerned about the negative sentiment from ETFs.

“Given record high outflows from U.S. HY bond ETFs, very high short interest ratios and rising costs of funding shorts, bearish sentiment in both U.S. high yield and high-grade bonds appears stretched and looks vulnerable to a reversal,” strategists led by Nikolaos Panigirtzoglou wrote in a recent note.

The strategists argue that the increased popularity and usage of ETFs is strengthening the overall ecosystem.

“Fixed-income ETFs are getting increasingly popular and, as a result, are adding liquidity to the mostly illiquid corporate bond market,” the BofA strategists concluded.

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