Investors Dumped Stocks For Bond ETFs In January
ETF investors are dumping stocks for bonds, but potential trading problems with fixed-income ETFs could trim their results. In January, investors pulled $18.4 billion out of stock ETFs and poured $2 billion into bond ETFs, according to Morningstar Inc. Scott Freeze, president and CEO of Street One Financial, a specialty broker-dealer that trades ETFs for portfolio managers,” Trang Ho Reports From Investors Business Daily.
IBD: What are the current risks of buying fixed-income ETFs?
Freeze: Some fixed-income ETFs hold bonds that do not trade frequently, and/or there is not a deep market in certain bonds, especially those of lower quality, creating pricing disparity on the basket level from trading desk to trading desk. In addition, because it is a very specific subset of bonds that make up the underlying components, any mass pressure to buy or sell the ETF will result in exponentially greater price impact than if the holdings were spread through more issues or more liquid products like many equity ETFs. The final risk is that you may lose principal on a long position in a fixed-income ETF if interest rates rise, due to the inverse correlation between interest rates and the price of bonds.
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IBD: How will higher interest rates affect fixed-income ETFs such as iShares Barclays Capital U.S. 20+ Year Treasury Bond (TLT), iShares Barclays 1-3 Year Treasury Bond (SHY) and iShares iBoxx $ High Yield Corporate Bond (HYG)?
Freeze: Obviously the prices of all three ETFs will fall due to the inverse relationship between yields and prices. With TLT and SHY, the underlying basket is so liquid that the price impact should be a normalized drop due to the rate increase, and a mass exodus out of those names could be handled in an orderly manner. HYG is corporate and not as tied to the interest-rate moves by the Fed. It will likely see a drop along with the other fixed incomes, but its price movement would be more of a bet on whether the companies comprising HYG can recover. Because HYG has such a small underlying basket, a mass exodus would be catastrophic from a pricing standpoint.
IBD: Given their trading volume and the amount of assets under management in these ETFs, why do they often have such high bid/ask spreads? Sometimes it’s as much as $2 a share.
Freeze: Credit dislocation. That’s the forced liquidation in hedge funds in fixed income because of ratings downgrades. So “babies were thrown out with the bathwater” just because something went from an A- to a C overnight. And no one would bid for the stuff.
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