“The BIS said the NAV discounts were a reflection of liquidity providers offering less support to the corporate bond market which limited the arbitraging of NAV discounts."
The recent all-time high discounts seen across fixed income ETFs highlights how ETFs incorporate information “in a more timely manner” than their underlying bonds, according to a recent report from the Bank for International Settlements (BIS).
The report, entitled The recent distress in corporate bond markets: cues from ETFs, analysed the impact that mutual funds’ large outflows and secondary market yield spreads to government securities has had on European and US corporate bond ETFs.
In mid-March, a large volume of corporate bond ETF discounts dropped significantly below the values of their underlying NAV driven by high market volatility, reduced risk-taking by dealers and investors’ reaction policy decisions.
According to the BIS, the discounts highlight how NAVs are slower to incorporate information than ETF prices amid a relative illiquid corporate bond market.
Furthermore, the BIS said the NAV discounts were a reflection of liquidity providers offering less support to the corporate bond market which limited the arbitraging of NAV discounts. Additionally, money market funds saw large inflows after the US federal banking regulators launched the Money Market Mutual Fund Liquidity Facility.
These events have brought to light how quickly ETF prices react to market developments compared to the prices of the underlying bonds – even more so during periods of market stress. Therefore, ETF prices are likely to be more accurate than stale bond benchmarks at risk management modelling and underpinning regulatory capital calculations.
Corporate bond liquidity has struggled to recover ever since the Global Financial Crisis in 2008 which impacted all asset classes, however, most have rebounded. The BIS says the economic reaction to the coronavirus outbreak has provided further evidence that corporate bond liquidity remains fragile.
Investors were suffering heavy losses by mid-March and mutual funds were focusing on high yield credit which also came under pressure as outflows started accumulating. As a result, there were a number of cases where mutual funds had to be gated, according to the bank.