Noel Archard: A friend of mine recently told me she doesn’t like my blog posts as they’re too complex. She prefers Kevin’s weekend reading list over my “technical-manual ramblings”. In an attempt to stir things up, I’m going to write about the dead-sexy topic of risk-off trades and our old friend, price discovery.
Our Capital Markets team has seen a healthy degree of trading in (and some redemptions out of) riskier asset classes over the past week due to global concerns of a Greek default, a cooling Chinese economy and recent weak US economic numbers. High yield bonds in particular have been a favorite for income generation for most of the year, but have come under some strain recently due to the concerns mentioned above.
For example, on Thursday June 16th our iShares iBoxx $ High Yield Corporate Bond ETF (NYSE:HYG) traded more than 7 million shares for the day, which is 5x more than the 30 day average daily volume (ADV) and an all time high. State Street’s SPDR Barclays Capital High Yield Bond ETF (NYSE:JNK) saw similar record volumes, trading 5x more than its 30 day ADV. Amidst all this volume, HYG closed with a 201 basis point discount to net asset value (NAV) that night versus a year-to-date average premium of 48 basis points. JNK traded in line with HYG, closing with a 195 basis point discount to NAV as of close.
Is the temporary difference between market price and NAV a cause for alarm or celebration? If you’re a market efficiency geek like me, it is the latter (we’ll put aside emotions around watching your investment decline and take solace in the fact that high yield markets started to move north Friday). The difference is caused by the fact that the benchmark values (and most NAV calculations) are generally calculated based on the last known traded price of the underlying bonds. On a day like Thursday, the broad market in high yield bonds was largely inactive (outside of the most heavily traded names) because nobody was buying. Bond investors shied away from low credit names, and the ETFs became the primary liquid vehicle through which investors could manage their diversified long bond exposure. The ETFs become a representation of the perceived market value of the underlying securities until they begin trading again. And when the cash bonds do begin trading, guess what the bond dealers tend to use as a pricing marker? You guessed it – the ETFs.
Simply fascinating, right? Let’s watch Kevin try and top this!
Bonds and bond funds will decrease in value as interest rates rise. High yield securities may be more volatile, be subject to greater levels of credit or default risk, and may be less liquid and more difficult to sell at an advantageous time or price to value than higher-rated securities of similar maturity.
Although market makers will generally take advantage of differences between the NAV and the trading price of iShares Fund shares through arbitrage opportunities, there is no guarantee that they will do so. There can be no assurance that an active trading market for shares of an ETF will be maintained.
Noel Archard, CFA is a Managing Director and Head of Product for North America iShares. He currently heads the iShares product function in the US, which is responsible for product research and development, product management, the management of iShares in capital markets and product services and analytics. Noel joined iShares in 2006, then part of Barclays Global Investors (BGI), which merged with BlackRock in December 2009. He spent over 10 years at The Vanguard Group, first working with their brokerage service unit and then moving into their Exchange Traded Funds group.
Noel has a BS degree from Northwestern University and is a Chartered Financial Analyst charterholder (CFA). He is a member of the Financial Analysts of Philadelphia and the CFA Institute, and holds Series 7, 24, 63 and 65 securities licenses.