High yield bond ETFs more safety valve than agent of instability - Morningstar

Added 7th June 2016

New research by Morningstar challenges assumptions about the threat ETFs pose to the stability of high yield markets, especially during times of crisis.

High yield bond ETFs more safety valve than agent of instability - Morningstar

High yield bond ETFs have grown significantly in the past decade from a standing start to now accounting for over $51bn. And, their high visibility within a market into which many investors have been forced by low returns and the hunt for yield means questions are increasingly being raised about how they will react should liquidity dry up.

In a new report titled:  High-Yield Bond ETFs – A Primer on Liquidity, senior ETF analyst, Jose Garcia-Zarate, looks at the increasingly important role being played within the high-yield market by ETFs and argues: “Far from being agents of instability, high-yield bond ETFs have acted as a safety valve in a marketplace where, largely because of post-crisis banking regulation, the availability of ready-to-trade fixed-income inventory has been on a declining trend.”

Zarate’s conclusion is based on an analysis of the difference between the primary and secondary markets layers of liquidity within ETFs markets, a distinction crucial, he says, in understanding how ETFs actually trade.

Indeed, he adds: “One of the most common misconceptions when it comes to ETFs and liquidity is that every purchase or sale of an ETF share necessarily has an impact on the underlying market.”

While acknowledging that ETFs can never be more liquid than the underlying market they track, he points out that investors in ETFs also operate in the secondary market, buying and selling existing ETF shares like common stock by means of traditional market-making channels, which adds an extra layer of liquidity. And, it is only when there is a supply/demand imbalance within the secondary markets that ETF providers have to create or redeem units.

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Geoff Candy

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Geoff Candy joined Portfolio Adviser as News Editor in May 2014. He has been a financial journalist and broadcaster since 2005 and, in that time has worked in both South Africa and the Netherlands, covering everything from high street retailers and construction companies to mining and insurance.

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