Uncategorized

Fixed income ETFs may risk pushing market into liquidity crisis


In a paper titled ‘Steering a Ship in Illiquid Waters: Active Management of Passive Funds’, the co-authors suggested that the use of authorised participants (APs) to handle inflows and outflows from ETFs left them vulnerable to worsening a liquidity crisis.

This is because during a crisis, APs may “become reluctant to purchase more of the same bonds, reducing their liquidity”, despite the demand of the ETF, the paper said.

This would lead to worsening price dislocations, adding further stress to the corporate bond market.

This is despite views that ETFs are simply passively copying the market, which the authors said is “somewhat misleading”, given that that fixed income ETFs are “remarkably active” in their portfolio management.

Fixed income ETFs differ from equity ETFs, as their creation and redemptions baskets tend not to include every bond in the index that the ETF tracks, as this often includes thousands of various issuers.

The academics looked to the pandemic crash of March 2020, which saw those bonds heavily represented in redemption baskets also become “heavily represented in APs’ inventory”.

APs then became reluctant to purchase more of the same bonds due to balance sheet constraints, meaning that bonds present in redemption baskets lost their most natural buyers.

“When its own market makers do not want to buy it, a security can become quite illiquid,” the paper concluded.



READ SOURCE

This website uses cookies. By continuing to use this site, you accept our use of cookies.