Junk ETF Bond Volumes Signal Electronic Demand: Credit Markets
Trading of exchange-traded funds that focus on junk bonds is soaring while volume in the underlying securities slumps as dwindling dealer holdings prompt investors to seek electronic platforms.
Volumes in the two biggest ETFs in June have climbed 22 percent above the six-month average while overall trading for the debt has sunk 9 percent, according to data compiled by Bloomberg. A record $1.67 billion of shares was traded May 31 in the funds from BlackRock Inc. (HYG) and State Street Corp. (JNK), equivalent to 35 percent of the day’s total volume for U.S. junk debt.
Junk ETFs are providing liquidity for investors who want to accumulate and unload risky assets quickly as Europe’s sovereign-debt crisis escalates with dealer inventories dropping 81 percent from the 2007 peak. The funds are luring institutional investors while firms from BlackRock to Goldman Sachs Group Inc. (GS) form electronic bond-trading platforms as dealers become less willing to hold capital as a buffer against losses on corporate debt.
“Hedge funds and individual investors recently may be able to articulate a trade more efficiently” through ETFs rather than the actual bonds, said Jason Rosiak, head of portfolio management at Pacific Asset Management, an affiliate of Pacific Life Insurance Co. in Newport Beach, California. “That could be considered an indictment on the bid-offer spread increasing due to dealers not taking a significant amount of risk.”
New regulations from U.S. Congress and the Basel Committee on Banking Supervision are spurring the biggest banks to pare holdings of corporate bonds to $44.6 billion as of June 6 from a peak of $235 billion in October 2007, according to Federal Reserve data. Declining inventories are delaying trades as brokers are less able to use bank capital to buy notes and have to juggle price quotes from potential investors.
“Money managers are not used to bids and offers, they’re used to going to a dealer,” said Gary Gastineau, managing director at ETF Consultants. “ETFs will be much more important for trading.”
Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. fell, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, declining by 2.6 basis points to a mid-price of 117.9 basis points as of 3:37 p.m. in New York, according to prices compiled by Bloomberg.
The index typically falls as investor confidence improves and rises as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of bond market stress, fell 2.5 basis points to 27.25 basis points as of 3:37 p.m. in New York. The gauge narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.
Bonds of General Electric Co. (GE) are the most actively traded dollar-denominated corporate securities by dealers today, with 83 trades of $1 million or more as of 3:38 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
High-yield ETFs, listed on exchanges and brokered like stocks, are growing as the bond market stands to undergo the biggest transformation since Trace brought transparency to pricing in 2002. The funds have amassed $26.7 billion in assets since the first one began five years ago.
Trading volumes in BlackRock’s iShares iBoxx High Yield Corporate Bond Fund are an average 4 million shares a day in June through June 13, Bloomberg data show. That compares with a six-month daily average of 3.05 million shares, according to the data.
Daily volumes in State Street’s SPDR Barclays Capital High Yield Bond ETF were an average 6.3 million during the period, compared with a six-month average of 5.36 million, Bloomberg data show.
Markit Group Ltd. is responding to investor demand for trading alternatives for corporate debt with a set of indexes, one of which tracks the same iBoxx benchmark as BlackRock’s fund. The Markit indexes allow investors to bet on borrowers’ ability to repay their debt in a total-return swap format.
“In recent years, we have expanded their coverage across the fixed-income asset class to enhance transparency,” said Armins Rusis, Markit’s global head of data, indices and research, said yesterday in an e-mailed statement announcing the initiative.
Bloomberg LP, the owner of Bloomberg News, competes with Markit in selling information to the financial-services industry.
A measure of the gap between where dealers buy and sell debt quadrupled last year as Europe’s crisis escalated. The so- called bid-ask spread for 15 of the most-traded credit swaps on U.S. investment-grade companies expanded to 18.7 basis points on Oct. 4 from 4.85 on Aug. 3, according to market prices compiled by London-based CMA and Bloomberg. The gap has narrowed to 8.7.
The turmoil in Europe has roiled speculative-grade debt, with U.S. high-yield bonds losing 1 percent since the end of April, according to Bank of America Merrill Lynch index data.
High-yield, high-risk, or junk, bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s.
While Spain requests as much as 100 billion euros ($126.3 billion) of aid to shore up its lenders, the U.K. central bank has activated an unused plan to inject at least 5 billion pounds ($7.8 billion) a month into the financial system.
“Given the fact that a lot of the moves in the market are macro related, it fits to see a rise in the trading activity of index based asset-class products with bets being taken both long or short,” said Chris Taggert, a senior analyst at research firm CreditSights Inc. in New York.
High-yield ETFs are attracting a record volume of institutional investors, with the buyers accounting for 52 percent of BlackRock’s ETF and 62 percent of the fund from State Street.
In April, BlackRock said it was planning a bond-trading platform called Aladdin Trading Network to lower trading costs for customers. Goldman Sachs started a similar system, called GSessions, in May as it adapts to regulatory changes and competition.
MarketAxess Holdings Inc.’s electronic trading system for U.S. and European investment-grade, emerging markets and other types of bonds said in April that it had a record $58.7 billion of transactions during March.
“As trading becomes more difficult in the bonds, people will say trading in ETFs is more efficient,” said Chris Hempstead, director of ETF execution at WallachBeth Capital LLC in New York. “By trading the ETF, you’re transferring the onus for trading the bonds onto someone else.”
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