Since the first fixed-income ETF product launched in 2002, there has been
tremendous growth, not only in assets under management but also with
increased secondary market liquidity. This aspect of secondary market
liquidity is a driving force behind the potential benefits fixed-income
ETFs can provide over individual securities or mutual funds.
For instance, on screen liquidity for ETFs that track niche areas of the
market, such as high yield, trade at spreads roughly 40x tighter than the
underlying basket of constituents. Furthermore, these tight spreads are
accompanied by an abundance of volume on the secondary market as shown in
Figure 1 by the
SPDR Bloomberg Barclays High Yield Bond ETF (NYSE: JNK), which has a 30-day trading volume of more than 14 million shares ($231M
Fixed income ETFs expand upon their liquidity providing framework during
volatile markets. We have seen high-yield ETF volume and credit spreads
move in tandem during volatile times.
For example, as shown in Figure 2, when the price of oil precipitously fell
in the second half of 2014, it sparked contagion fears within the markets,
specifically in high yield. However, during this time, JNK provided a high
level of market liquidity by trading as much as 19 million shares ($779
million notional), nearly twice as much as its previous 30-day daily
In essence, during volatile times, fixed-income ETFs can provide liquidity
and price discovery for market participants when the underlying bond
markets might not be reacting as quickly.
The liquidity in the secondary market, along with the creation and
redemption mechanism, provides investors with the potential to transact at
fair and orderly prices with minimal market impact. Figure 3
provides a decomposition of actual large block trades transacted in the
market where over $50 million of JNK was traded 2-3 basis points below or
above the best bid or offer at the time of execution. A tight spread on an
ETF is important; however, a tight spread with robust order flow is an
essential tool in fixed income trading.
Creation and redemption
The primary method for creating or redeeming most fixed-income ETFs is
in-kind, where an Authorized Participant (AP) stands between the market and
the ETF sponsor. For a creation, the AP delivers the underlying basket to
the sponsor in exchange for shares of the ETF (for redemptions, it is the
Various methods exist for creating or redeeming ETF shares. These methods
include cash or a combination of both in-kind and cash. In the case of cash
creations, the AP delivers cash plus a variable fee to the fund sponsor. In
return, the AP receives the ETF shares to then trade on the open market or
deliver to a client seeking to gain exposure to the ETF.
Lastly, APs may also work with fund sponsors to execute custom create
(redeem) baskets, primarily sourced from existing dealer inventory, that
properly represents the overall risk contained within the ETF holdings (see
Bobby Eng is Vice President – Head of SPDR ETF Business Development
State Street Global Advisors. This article first appeared in the Fall 2017 issue of
Your Guide to ETF Investing, published by Brights Roberts Inc. Reprinted with permission.
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