After a year that has reignited concerns about how exchange-traded funds work during volatile periods, junk bond ETFs came through a test this month, registering their highest trading volumes ever without any major disruption.
The December selloff of high-yield bonds did not spark the kinds of price distortions that have occasionally roiled ETF markets, potentially soothing fears about the way the products trade as regulatory scrutiny ramps up.
Prices of junk bonds and the funds that hold them started falling precipitously on Dec. 7 as oil prices tumbled to new lows, adding to losses after mutual and hedge funds that invested in debt, led by the Third Avenue Focused Credit Fund on Dec. 10, froze redemptions.
The price of the two largest junk bond ETFs, BlackRock Inc's iShares iBoxx $ High Yield Corporate Bond ETF and State Street Global Advisors' SPDR Barclays High Yield Bond ETF, fell 4.3 percent and 4.5 percent, respectively, in the five trading days between Dec. 7 and to Dec. 14, registering trading volume unmatched in the history of the funds.
Daily average prices on the junk bond ETFs fell as low as 0.7 percent below the estimated value of the securities they held. While that was a widening of that spread, it was not out of the norm for ETFs, which regularly trade at slim discounts or premiums to the often-stale pricing of their portfolios' net asset values.
The products delivered nothing approximating the coarse showing by ETFs on Aug. 24 when a number of the popular funds, most invested in stocks, crashed 30 percent or more below the quoted market price of the securities they held before returning to fair value, and had their trading halted.
A high-yield rout around the same time in 2014, when oil prices were also tumbling, led to average discounts exceeding 1 percent in high-yield ETFs.
The worry this month expressed by investors such as Carl Icahn had been that with the underlying bonds being relatively illiquid, the funds might not be able to redeem shares smoothly. But that did not happen.
"We have had tests of the product structure over time," said Stephen Laipply, an investment strategist at BlackRock focused on the firm's bond ETFs. "This is another proof point that the product is functioning as it should."
BlackRock representatives emailed a rare Sunday-night statement declaring its junk-bond ETF "served as a positive force for financial stability."
The industry's providers are attuned to potential criticism, particularly as regulators including the Securities and Exchange Commission have said they are looking into ETFs and the trading issues that arose in August.
Critics have said the funds could be disproportionately hurt by fast selling, and have criticized the funds as trailing the benchmarks they are often designed to track faithfully.
Among the concerns: the middlemen who are needed to redeem shares may not always be willing to do so during a risky market selloff. ETF providers, such as BlackRock, say it is the very liquidity and transparency of the ETFs that make them useful as an escape valve during volatile days.
The junk bond ETFs have been trading dramatically for most of December. The ETF HYG fell in eight of the month's eleven full trading days, and gained in the other three, often in wild leaps. The $15.7 billion in volume from Dec. 7 to Dec. 15 broke records for the fund, according to BlackRock. Much of the demand was met by buyers and sellers on exchanges, not in redemption of the underlying bonds, they said.
As the markets faced strains this month, the gap between the market price of the junk ETFs and the quoted price of their junk bonds did widen briefly.
The two most widely traded junk-bond ETFs traded at an average 0.3 percent premium to the quoted value of the bonds they hold over the last year, according to FactSet Research Systems Inc. On Dec. 11, the discount widened to as much as 0.7 percent. By Monday, both funds returned to premiums closer to their averages.
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