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So far, 2012 has certainly been the year of the US-listed high
yield bond ETF. After pulling in US$7 billion in new flows for the
whole of 2011, the sector gathered almost the same amount in the
first three months of this year alone, led by the iShares iBoxx $
High Yield Corporate Bond ETF (NYSE Arca:HYG) and State Street's
SPDR Barclays Capital High Yield Bond ETF (NYSE Arca:JNK).
The driving forces behind the flows are well understood. We are
in an environment of very low yields, especially for government
securities. Investors, particularly those looking to generate
income, are challenged in finding investments that generate enough
income for their needs. High yield has been a beneficiary of this
environment, providing those investors who are comfortable with the
credit risk they are taking on with a way to boost income.
All of these inflows into high yield ETFs have rightfully raised
some questions about what impact the funds are having on the high
yield market. In my opinion, some of the issues are not always
Trading Activity And Market Impact
Some investors look at the size of the flows into high yield
ETFs and expect to observe pressure on both fund prices and the
underlying bonds themselves. If everyone buys something then its
price should go up, right? Despite their growth, ETFs are still a
small part of the high yield market. As of a month ago there was
US$29 billion invested in US high yield ETFs. That's less than 3
percent of the US$1 trillion US high yield market.
The combined daily exchange-based trading volume of HYG and JNK
is US$447 million, a significant increase over the volumes of just
a few years ago, but still a small number when compared to the high
yield bond market as a whole, which trades over US$5 billion a day.
The total inflows of US$7 billion into high yield ETFs during the
first quarter therefore represented less than two days of average
trading in the underlying market.
So from a size and trading perspective, high yield ETFs
represent just a small percentage of what is happening in the
broader high yield universe.
Premiums And Discounts
High yield ETFs will at times trade at premiums or discounts to
their underlying net asset values (NAVs). These premiums and
discounts reflect investor demand for the ETFs. When buying
interest is strong, premiums increase. When more investors are
selling, premiums decline. During periods of high yield market
stress high yield ETF premiums and discounts can have wider swings.
This is a reflection of the illiquidity and volatility of the
underlying high yield bond market. High yield ETFs are still ETFs.
If there is an actionable difference in price between an ETF and
its underlying holdings, then an arbitrage exists and investors
will try to take advantage of it. That same mechanism is in place
for high yield.
Simply put, in times of high market stress and volatility, a
larger channel can open up between an ETF's market price (at which
the fund trades) and the NAV (which is determined by the ETF's
index pricing point). But this is no different than holding the
bonds directly and observing a difference between the prices you
value them at and the prices at which you would actually be able to
buy and sell them.
But at pains of repeating the point, if the premium or discount
to NAV is in some way actionable, in so far as one could trade the
ETF against the underlying bond market and make a profit, then that
would of course occur and the gap between price and NAV would
So why are high yield ETFs under such scrutiny? Let's call it
the curse of transparency. By, for the first time, shining a light
on trading volumes, tradeable prices against valuation prices,
intraday liquidity and changing fund sizes, ETFs provide the only
real insight into the secondary market in an otherwise very opaque
My guidance is to enjoy the transparency and easy access that
high yield ETFs afford you whilst being mindful that many other
factors are driving the markets.
Alex Claringbull is
managing director and fixed-income portfolio manager for iShares
This article is for information purposes only and should not
be treated as a solicitation to buy or sell investment
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