Bond ETF Liquidity Concerns May Be Overblown

Markets ETF Trends

The growing popularity of bond exchange traded funds has been accompanied by increased liquidity concerns that some argue could threaten the balance of the markets. However, one of the main U.S. exchanges argues that bond ETFs actually make fixed-income markets more stable.

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Bats Global Markets contends that ETFs could be the “release valve” if bond markets came under pressure instead of exacerbating liquidity and compounding volatile swings, Financial Times reports.

SEE MORE: Addressing Corporate Bond Liquidity Challenges

The fixed-income segment of the ETF universe continues to expand, with long-dated debt funds attracting $70.35 billion in net inflows so far this year, compared to the larger universe of equity ETFs, which have only brought in $54 billion.

Investors have increasingly turned to bond ETFs as a means to gain exposure to fixed-income markets as ETFs allow anyone to access debt exposure through a basket of underlying assets, typically trading more frequently than the underlying debt securities.

However, some naysayers have warned that after plunge in yields and rising popularity of fixed-income ETFs, these bond ETFs that track illiquid debt securities could find it difficult to redeem shares in the event of a major sell-off if interest rates were to suddenly rise. Many market observers argued that while liquidity seems ample during normal conditions, liquidity can dry up during volatile conditions.

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SEE MORE: ETFs Help Bolster Market Liquidity for Investors in Times of Distress

However, Tony Barchetto, head of corporate development at Bats, believes concerns may be overblown.

“We think fixed-income ETFs can be the release valve rather than a pain point,” Barchetto said. “We don’t believe they make things worse; they make things better.”

Specifically, Barchetto pointed to the difference between buy and sell prices of ETFs, a key indicator of market liquidity. During periods of market turmoil, the difference between buy and sell prices rises and the amount available to trade declines.

BATS discovered that trading remained reasonably orderly across periods of volatility, including periods like the taper tantrum and more recently during the closure of Third Avenue, a junk bond fund that experienced huge redemptions.

“Yes, you do get less liquid conditions but this is normal,” Barchetto added. “Any asset class, any instrument under stress, is not going to see the same liquidity.”

Furthermore, due to the overall increased trading volumes, ETFs provide underlying bonds an additional source of price discovery, which further bolsters trading across credit products.

Money managers who are interested in learning more about the ETF industry and the investment vehicle can attend the in-person third annual ETF Boot Camp in New York on September 29-30. Want 50% off? Sign-up with a colleague and both use promo code “buddy” at checkout.

This article was provided by our partners at ETFTrends.