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Liquidity a key driver of fixed-income ETF benefits
4/19/2018 5:33:06 PM
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By Fund Library News Wire  | Thursday, March 15, 2018


 



By Bobby Eng, Vice President, State Street Global Advisors

Fixed-income ETFs have provided investors of many types, from large institutions to retail investors, an alternative tool to access the cash bond market. In this article, we highlight several key aspects of the fixed-income ETF trading dynamics to better assist investors in harnessing the utility of these instruments when implementing investment strategies.

ETF liquidity

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 notional).

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 average.

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 opposite).

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 Figure 4).

Bobby Eng is Vice President – Head of SPDR ETF Business Development Canada at 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.

Notes and Disclaimer

© 2018 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

THIS DOCUMENT IS PROVIDED TO YOU FOR INFORMATION PURPOSES ONLY.

The information we provide does not constitute any form of financial opinion or investment advice on the part of SSGA Canada or any of its affiliates and it should not be relied on as such. It does not constitute a prospectus, offering memorandum or private placement memorandum in Canada, and may not be used in making any investment decision. It should not be considered a solicitation to buy or an offer to sell a security in any jurisdiction. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. We encourage you to consult your tax or financial advisor.

This document may not be disclosed, distributed, copied, reproduced or used (in whole or in part) for any purpose without the express written consent of State Street Global Advisors Ltd. (“SSGA Canada”).

Units of the investment vehicles described in this document are not distributed or sold by SSGA Canada. Investors are advised to communicate with their appointed broker for further information on the investment vehicles described in this document. This document contains only summary information solely for educational purposes and no representation or warranty, express or implied, is or will be made in relation to the accuracy or completeness of the information contained, by SSGA Canada or any of its affiliates, including, for the avoidance of doubt, State Street Bank and Trust Company, State Street Global Advisors Trust Company, State Street Global Markets, LLC and State Street Global Advisors Funds Distributors, LLC. SSGA Canada and each of its affiliates expressly disclaims any and all liability which may be based on this document and/or any error herein or omission here from.

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© 2017 State Street Corporation. All Rights Reserved. ID9131-CanMkt-3524 0716 Exp. Date: 12/31/2017

 
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