By Adam Gould, Head of U.S. Equities, Tradeweb
Since their inception in the early 2000s, fixed income exchange traded funds (ETFs) have always sparked debate among financial markets professionals. Advocates point to the ability to gain instant exposure to a broad range of securities with lower transaction costs and, in some cases, better overall liquidity than the underlying bonds themselves. Detractors warn that the potential for a liquidity mismatch between the ETF and its underlying products could create a recipe for trouble during periods of heightened volatility.
Who’s right? Tradeweb recently assembled a panel of experts on the topic to examine the performance of fixed income ETFs over the last several months of COVID-19-inspired volatility, taking a close look at how the asset class performed throughout some of the most challenging conditions we’ve seen since the Global Financial Crisis. Their consensus: fixed-income ETFs have passed the test.
By-the-Numbers: Weathering the Crisis
Steve Laipply, U.S. Head of iShares Fixed Income ETFs at BlackRock kicked things off by explaining that the asset class has become an integral part of the fixed income ecosystem. Breaking it down a bit further with hard data, fund flows throughout the COVID-19 crisis were significant.
“As of February of this year, we had about $31 billion in net inflows into fixed income ETFs. In March, during the height of the COVID-19 crisis, we saw $18 billion in net outflows,” Laipply explained. “Then, as stimulus measures were announced, we saw a turnaround of $20 billion in inflows in April and $30 billion in May. All told, we’re roughly $60 billion net positive inflows for the whole period.”
He added that fixed income ETFs functioned as a strategic tool for institutional investors during the crisis – particularly in credit markets – with broker dealers, electronic trading platforms and market makers routinely using fixed income ETFs to manage inventory, facilitate large client trades and hedge risk.
Tradeweb’s Iseult Conlin, U.S. Institutional Credit Product Manager, added more context on how market participants have been tapping into multiple asset classes to find liquidity during the crisis: “One of the advantages of Tradeweb is the fact that we are a multi-asset fixed income platform operating in forty different markets. So, traders using our platform can simultaneously send a request for quote (RFQ) list of corporate bonds while also trading an ETF. That seamless flexibility has been important, particularly in periods of heightened volatility, where we see traders becoming well-versed in many different products and trading across asset classes to find liquidity.”
A Bright Spot in Stressed Markets
Looking beyond fund flows to actual fixed income ETF performance during the crisis, the panel focused on the critical role the asset class played in providing liquidity.
BlackRock’s Laipply provided context: “During the height of volatility in March, where we saw spreads blow out from 100 basis points to 375 basis points in investment grade credit and from 300 to 1,100 basis points in high yield, fixed income ETFs stepped into the gap in liquidity in the underlying bond market.”
To put this in perspective, BlackRock traded roughly $1.3 trillion in fixed income ETF volume in the first quarter of 2020. That compares with $2.6 trillion for all of 2019.
“We saw roughly 50% of all of 2019’s volume trade in the first quarter of 2020 alone. The fact that all of this trading activity was occurring against a backdrop of very stressed underlying markets shows that investors were able to turn to fixed income ETFs at a time when they were having real difficulty moving trades in the underlying over the counter markets,” Laipply added.
Matheus Lara M. Pereira, Head of Trading at Flow Traders echoed this sentiment, sharing examples of trades that were stalling in the underlying bond markets, but moving freely in the ETF market: “We were seeing clients unable to execute a $100 million inflation TIPS basket on the underlying product and then turning to get pricing on similarly sized blocks of TIPS ETFs that were able to be executed immediately so they knew exactly what price they were getting and then executing via the Tradeweb platform to get the best price. It was much more efficient and easy to price by accessing that risk in the ETF market than in the underlying bond market.”
Tradeweb’s Conlin added that the velocity of trading increased significantly during this crisis, thanks largely to improved transparency offered by the ETF market: “Liquidity was very challenged in March in underlying cash bonds, particularly on the front end. Corporate traders on Tradeweb leveraged fixed income ETFs to gain insight into pricing and liquidity and as a diversified trading strategy – other than RFQ or voice protocol – to move risk in the underlying corporate cash market.”
Conlin added that newer trading technologies also played a role in helping to spur liquidity when markets were severely stressed at the height of the pandemic. Specifically, Tradeweb saw a large uptick in usage of its portfolio trading protocol – which allows investors to price hundreds of bonds in one basket, negotiate a price at a portfolio level with multiple dealers and execute the trade in a single transaction. “That was a real departure from previous crises, where traders would typically revert back to ‘conventional methods of trading’ via voice. With this crisis, traders doubled-down on technology as the most effective means of finding liquidity.”
“If you think about how the bond market is modernizing, it’s really all about technology. We tend to think about fixed income ETFs as a technology, but the infrastructure that’s being built to either support or make trading itself in single names or portfolio trading is a very key component of this,” Laipply added. “This was a very powerful stress test. We have strong conviction that fixed income ETFs will pass this test.”
Click here to access a recording of the full panel discussion.
