Tag Archives: NAV

bond etf liquidity

Calling for Clarity: Corporate Bond ETF Liquidity

There continues to be a call for clarity with regard to the topic of corporate bond ETF liquidity and where/how corporate bond ETFs add or detract within the context of investors ability to get ‘best execution’ when secondary market trade in underlying corporate bonds is increasingly ‘illiquid.’

This not only a big agenda item for the SEC to wrap their arms around, it is a challenge for “market experts” to frame in a manner that resonates with even the most knowledgeable bond market players.

MarketsMuse curators noticed that ETF market guru Dave Nadig penned a piece for ETF.com last night “How Illiquid are Bond ETFs, Really?” that helps to distill the discussion elements in a manner that even regulators can understand.. Without  further ado, below is the opening extract..

“Transcendent liquidity” is a somewhat silly-sounding phrase coined by the equally silly Matt Hougan, CEO of ETF.com, to discuss the odd situation in fixed-income ETFs—specifically, fixed-income ETFs tracking narrow corners of the market like high-yield bonds.

But it’s increasingly the focus of regulators and skeptical investors like Carl Icahn. Simply put: Flagship funds like the iShares iBoxx High Yield Corporate Bond ETF (HYG | B-68) trade like water, while their underlying holdings don’t. Is this a real problem, or a unicorn?

Defining Liquidity

The problem with even analyzing this question starts with definitions. When most people talk about ETF liquidity, they’re actually conflating two different things: tradability and fairness.

Tradability is actually a pretty simple concept: How well will the market let me get in or out of an ETF? And for narrow fixed-income ETFs (I’m limiting myself to corporates, in this analysis), most investors should be paying attention to the fairly obvious metrics, e.g., things like median daily dollar volume and time-weighted average spreads. By these metrics, a fund like HYG looks like the easiest thing to trade ever:

On a value basis, the average spread for HYG on a bad day of the past year is under 2 basis points. It’s consistently a penny wide on a handle around $80, with nearly $1 billion changing hands on most days. That puts it among the most liquid securities in the world. And that easy liquidity is precisely what has the SEC—and some investors—concerned.


But that’s tradability, not fairness. Fairness is a unique concept to ETF trading. We don’t talk about whether the execution you got in Apple was “fair.” You might get a poor execution, or you might sell on a dip, but there’s no question that your properly settled trade in Apple is “fair.”

In an ETF, however, there is an inherent “fair” price—the net asset value of the ETF at the time you trade it—intraday NAV or iNAV. If the ETF only holds Apple and Microsoft, that fair price is easy to calculate, and is in fact disseminated every 15 seconds by the exchange.

But when the underlying securities are illiquid for some reason (hard to value, time-zone disconnects or just obscure), assessing the “fair” price becomes difficult, if not impossible.

If the securities in the ETF are all listed in Tokyo, then your execution at noon in New York will necessarily not be exactly the NAV of the ETF, because none of those holdings is currently trading.

Premiums & Discounts

In the case of something like corporate bonds, the issue isn’t one of time zone, it’s one of market structure. Corporate bonds are an over-the-counter, dealer-based market. That means the iNAV of a fund like HYG is based not on the last trade for each bond it holds (which could literally be days old), but on a pricing services estimate of how much each bond is worth. That leads to the appearance of premiums or discounts that swing to +/- 1%.

To read the full article, please click here

Sell This Rumor: Hedge Funds Exploit ETF Ecosystem

The battle between business news pontificaters across the 4th estate is in full season, as evidenced by a smart article yesterday by Bloomberg LP’s Eric Balchunas and suggests that MarketsMuse curators are apparently not the only topic experts who noticed and took aim at a recent WSJ article that proclaimed savvy hedge fund types are increasingly exploiting exchange-traded funds by arbitraging price anomalies between the underlying constituents and the ETF cash product that occur in volatile moments.

That original WSJ article, “Traders Seek Ways to benefit from ETF woes …At the Expense of Investors” was misleading, and as noted by MarketsMuse Sept 30 op-ed reply to the WSJ piece, one long time ETF expert asserted that WSJ’s conclusions was “much ado about nothing.” Bloomberg’s Balchunas has since reached a similar conclusion; below are extracted observations from his Oct 12 column..

Hedge funds may need to get back to the drawing board if they’re planning to turn around their performance struggles by capitalizing on “shortcomings in the ETFs’ structure” via some unusual trade ideas, as highlighted in this recent Wall Street Journal article. Most funds do nothing of the sort.

Eric Balchunas, Bloomberg LP
Eric Balchunas Bloomberg LP

The vast majority of ETF usage by hedge funds is very boring. They love to short ETFs to get their hedge on and isolate some kind of risk. For example, they may short the Health Care Select Sector SPDR ETF (XLV) and then make a bet on one of the health-care stocks in the basket in order to quarantine a single security bet. Hedge funds have about $116 billion worth of ETF shares shorted, compared with only $34 billion in long positions, according to data compiled by Goldman Sachs last year.

The $34 billion in long positions is them using ETFs like everyone else — as a way to get quick and convenient exposure to a particular market. For example, the world’s largest hedge fund, Bridgewater Associates, has a $4 billion position in the Vanguard FTSE Emerging Markets ETF (VWO), which it has held for six years now.  There’s also Paulson & Co.’s famous $1 billion position in SPDR Gold Trust (GLD), which it has been holding for almost seven years. Like anyone else, they like the cheap exposure and liquidity VWO and GLD serve up.

With that context in place, yes, there are a tiny minority of hedge funds that engage in some complex trades like the ones highlighted in the article. But each trade comes with at least one big problem.

Before anyone tries any of these at home, it’s important to deconstruct them.

Trade #1: Robbing Grandma

How it works: During a major selloff, try and scoop up shares at discounted prices put in by small investors using market orders.

The problem: It’s super rare. Aug. 24, which saw hundreds of ETFs trade at sharp discounts amid a major selloff, was basically an anomaly. At best, a day like that happens once every two years. Thus, to capitalize on discounts of the 20-30 percent variety is like standing on a beach waiting for a hurricane to hit. And you won’t be the only one, so you may wait two years only to find you can’t get your order filled on the day the big one hits. In addition, no large institutional investors are putting in market orders. So this low-hanging fruit is sell orders for tiny amounts put in by unknowing small investors. Essentially this is the white-collar equivalent of robbing Grandma for some loose change in her purse.

Moreover, Aug. 24 may never happen again, at least the way it unfolded. ETF issuers are working with the exchanges, the regulators, and the market makers — and even making significant recommendations — to make sure those kinds of small investors aren’t exposed again like that.

It should be noted, though, that arbitrage between the ETF price and the value of the holdings happens day in and day out with ETFs — that’s how ETFs work. They rely on a network of market makers and authorized participants to arbitrage away the discrepancy between the ETF’s underlyings and its net asset value (NAV).

Trade #2: The Double Short

To continue reading the straight scoop from Bloomberg columnist Eric Balchunas, click here

Assessing the Merits of an ETF: Debunking Common Myths

Extract of white paper published by Chris Hempstead, Head of ETF Trade Execution for WallachBeth Capital LLC

With respect to analyzing and selecting ETFs, one of the most common and frustrating mistakes that I overhear is “..unless the fund has at least some minimum AUM ($50mm in many cases), or has average daily trading volume less than [some other arbitrary number] (say 250k shares) it should be avoided…”

Some other arguments against ETFs go so far as to suggest that “..ETFs need to have a certain history or track record before they should be considered…” Adding insult to injury is the claim that “investors are at risk of losing all their money if an ETF shuts down.”

In light of recent articles being picked up by media from New York to Seattle, I would like to dismiss a few of these common, yet unwarranted reasons to avoid an ETF based solely on AUM, ADV or track record.

 First, let’s address AUM:

“ETFs with less than $50mm should be avoided”

In order for an ETF to come to market (list on an exchange) the fund needs to have shares created. This process is often referred to as “seeding”. The ‘seeder’ is the initial investor who delivers into the custodial bank the assets required to back the initial tradable shares of the ETF in the secondary market. ETFs issue shares in what are known as creation units. The vast majority of ETFs have creation unit sizes of 25k, 50k or 100k shares.

When a ‘new’ fund comes to market, they are usually seeded with at least 2 units of the fund. There are very few examples of ETFs that come to market with more than $5mm in AUM or an excess of 200k shares outstanding. One recent exception comes to mind: Pimco’s BOND launched with ~$100mm AUM and 1mm shares outstanding.

Understanding that ETFs have to start somewhere, it would be difficult to explain how more than 55% of ETFs (excluding ETNs, Leveraged ETFs and Inverse ETFs) have garnered AUM in excess of $50mm.

In other words, someone had to take a close look and invest into the funds. The ‘I will if you will’ mentality is probably not how the most successful fund managers find ways to outperform.

Ten of the top thirty performing ETFs year to date have AUM below $50mm.


Congratulations to the pioneers who ‘went it alone’, as they say. Continue reading