PRESSURE TESTED

Sending a clear signal: Fixed income ETFs show where bond markets are trading in real time

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Summary

• Investors have increasingly turned to fixed income ETFs for clarity and colour on what is happening in the bond markets. 
• Fixed income ETFs can accurately reflect the conditions of the markets while improving price transparency, providing access to liquidity and offering immediacy of trading that has not been available in individual bonds during this unprecedented period of market stress. 
• In times of uncertainty, investors used fixed income ETFs as a tool to rebalance holdings, hedge portfolios and manage risk.

Amid market turmoil through February and March 2020, spurred by pandemic concerns, investors increasingly turned to fixed income exchange traded funds (ETFs) for clarity about what was happening in the bond markets. The market volatility seen during this period demonstrated how fixed income ETFs can accurately reflect the conditions of the markets while improving price transparency and providing access to liquidity in periods of market stress.

Commentators have long speculated about what would happen should fixed income ETFs be tested by a once-in-a-generation market shock and raised questions about whether ETFs can withstand waves of selling. From February and March 2020 show that ETFs held up well in extreme fixed income market conditions, offering liquidity to investors. Investors turned to the most liquid bond ETFs to help them navigate bond market dislocations. As they did so, these flagship ETFs became sources of real-time price discovery for markets where transparent quotations and trading activity deteriorated.

As bond markets got more volatile, investors flocked to fixed income ETFs

As financial market volatility increased from late February through late March 2020, iShares UCITS fixed income ETFs traded an average of US$17.5B (21 February – 20 March), more than twice the 2019 weekly average of $7.8B.¹

Investors have traded fixed income ETFs more in times of uncertainty, we believe this is because they make it convenient to rebalance holdings, hedge portfolios and manage risk. The largest trading days during this period saw record days of secondary market trading in several flagship ETFs such as a large €-denominated corporate bond UCITS ETF, reaching $1.2B on 6 March, this is 6.6x the fund’s 12-month Average Daily Volume (ADV). Secondary market trading in a large €-denominated high yield corporate bond UCITS ETF was equally high at $590M on 13 March (5x ADV).²

Across a range of ETFs that seek to track bond indexes, the implication is clear: as markets became more volatile, investors flocked to fixed income ETFs.

1. Source: Bloomberg as at 20 March 2020
2. Source: Bloomberg as at 20 March 2020

As more investors turn to fixed income ETFs, they are becoming real-time price indicators

Fixed income ETFs trade frequently, allowing ETF prices to incorporate more real-time information than even the most heavily traded portfolio bonds. This is especially true during volatile markets as ETF trading activity increases. Below we highlight an example where ETFs have shown to be a source of price discovery.

On 12 March, one of the worst days for U.S. stock benchmarks in modern history, shares of iShares a large $-denominated corporate bond UCITS ETF changed hands more than 1,000 times on exchange and over the counter (OTC), while its top five underlying holdings traded an average of only 37 times each. Throughout March 2020, more than half of this ETF’s bonds traded between zero and five times per day, on average, while the ETF traded regularly more frequently than the bonds in the underlying portfolio. ³ 

3. Source: Blackrock, TRACE as at 24 March 2020

Fixed income ETFs have
performed as expected

Investors ultimately use index-tracking bond ETFs to seek index performance. Many of the flagship iShares fixed income ETFs have provided this, even in the face of extreme volatility. And March market volatility has not impacted longer-term index tracking. Performance and tracking information for every iShares ETF is available for all investors on a daily basis.

¹During stressed markets, iShares UCITS fixed income ETFs traded an average of US $17.5B (21 Feb - 20 Mar 2020), more than twice the 2019 weekly average of $7.8B. All amounts in $USD.