Should fixed-income ETF haters dial it down?

A re-examination of three arguments against the bond-based vehicles reveals major misconceptions

Should fixed-income ETF haters dial it down?

As fixed-income ETFs gain more popularity among investors seeking safety, critics have questioned whether they’re being used wisely. But the arguments raised by skeptics may not be so ironclad.

In a commentary published on the SPDR Blog, Matthew Bartolini, head of SPDR Americas Research, took aim at the narrative that fixed-income ETFs haven’t been tested, are setting up a crisis by providing daily liquidity to an illiquid asset class, and are taking up too much market share.

“ETFs have absolutely been tested throughout their tenure,” Bartolini wrote. Conceding that the economic expansion since the 2008 financial crisis has been the longest in history, he pointed out that fixed-income ETFs have weathered numerous market events — the 2011 US Sovereign Debt Downgrade, the 2013 Taper Tantrum, and the volatility events of 2018, to name some — without being forced to liquidate or gate redemptions.

Turning to the issue of liquidity mismatches, he then argued that fixed-income mutual funds also provide daily liquidity to an illiquid asset class; with that in mind, investors should ask which offers superior liquidity to tap into in times of economic or market stress.

“Fixed income ETFs provide two layers of liquidity (secondary and primary market) to mutual funds’ single-only layer (primary),” he noted. With a liquid secondary market, investors benefit from price transparency and the ability to liquidate positions without touching the primary market. “This dynamic negates the view of providing liquidity to an illiquid asset class, as not all transactions actually touch the asset class.”

Mutual funds, he continued, can only be redeemed at the market close, with the fund manager raising capital through primary-market trading in order to fulfill any redemption requests. With greater transactional flexibility, ETFs offer greater benefit to investors. Even discounting the secondary market, Bartolini added, a difference in operational nuance — sales of mutual fund shares settle on a T+1 basis, while both primary and secondary ETF trades settle at T+2 — means that fixed-income ETFs still win out based on operational flexibility.

Finally, he turned to examine the impact ETFs may be having on the underlying bond market. After taking a census of every listed ETF across several bond sectors, he looked at the associated secondary market trading volume data covering the past five years, as well as data on gross daily primary fund flow activity; from that, he determined the aggregate secondary-to-primary market ratio for each sector. As a secondary test, he determined the consolidated AUM for each sector category of fixed-income ETF, and determined their relative size as a percentage of their respective bond sectors’ underlying market value.

He determined that the fixed-income ETF marketplace is small relative to the broader bond market, with no class of fixed-income ETF having more than a 5.3% share of its respective bond sector’s market value. He also found that secondary-to-primary market ratios for all sectors were greater than 1, showing that primary markets across all sectors are fairly well-insulated from trades.

“Rather, there are transactions that occur in the secondary market that are just between willing buyers and sellers at the fair market price for a basket of bonds and do not require any bond to be touched,” he said.


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