Mark Wiedman believes the corporate bond marketplace is facing big problems when interest rates start to rise, however the global head of BlackRock Inc. iShares isn\’t overly concerned about the impact that may have on his firm\’s lineup of fixed-income exchange-traded funds.
To the contrary, Wiedman sees no reason to believe that ETFs is going to be any less resilient compared to what they were in the past periods of market stress despite growing concerns from others the liquidity underpinning corporate bond ETFs has already been lacking and can deteriorate further in a major downturn.
\”People say ETFs will blow up under the stress, but they only became more active in difficult periods previously,\” he explained in an interview this week. \”They actually performed better.\”
Wiedman said the chance of a liquidity crunch for corporate bonds is extremely real, particularly when the U.S. Fed starts to raise rates, perhaps as soon as later this year.
He said it\’s become much harder to trade bonds because the financial crisis because regulations make it increasingly expensive for banks to fulfill their market role as primary dealers intermediating with respect to buyers and sellers.
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\”They have responded rationally by cutting back their activities,\” Wiedman said. \”Some banks have shuttered their fixed-income operations, others have cut back on the inventory they carry.\”
At the same time frame, the supply of corporate bond issuance continues to increase, resulting in a lower proportion of outstanding bonds that banks readily offer to trade as primary dealers.
But as the primary marketplace for corporate bonds is negatively affected in this scenario, the ETFs which are invested in options are not impacted in the same way, Wiedman said, leading increasingly more fixed-income investors in that direction during times of stress.
For example, the iShares iBoxx $ High Yield Corporate Bond ETF units trading in the U.S. spiked in terms of a percentage from the overall cash bond volume trading following the Lehman Brothers collapse in 2008 and there was another big spike following former Fed chair Ben Bernanke’s taper speech in 2013.
That’s because ETFs do not rely on a primary dealer, Weidman said, and trade on exchange or secondary markets that allow buyers and sellers to transact without a bank intermediary.
ETFs, in other words, provide secondary or incremental liquidity towards the primary bond market and offer investors a transparent, continuous price even when the banks shut down.
“Some observers say this liquidity is illusory, but that’s incorrect,” he said. “It’s real secondary liquidity that isn\’t touching the primary liquidity in the underlying bond market.”
Of course, ETFs trade on the primary bond market in order to create and redeem shares, but Wiedman said the vast majority of trades are performed on the secondary market even in periods of market stress.
“The worst-case scenario for the liquidity of an exchange-traded fund is that it acts in accordance with the underlying market and that would only happen if the secondary channel stopped working entirely there was no price that buyers and sellers can agree on,” he said.