In addition to the Treasury ETFs launched this week, SSgA should soon be rolling out corporate credit ETFs as well. The prospectus for the five new Treasury ETFs also included listings for three corporate ETFs: short-, mid- and long-term corporate credit.
All of these funds, like the BGI fixed-income ETFs, use a sampling methodology: they buy some but not all of the bonds in the underlying indexes, and hope that this subset delivers similar returns to the broader index. The reason is that the fixed-income market has lots and lots of similar securities; it would be hard for Authorized Participants (AP) to create complete creation baskets including all of the individual securities in the indexes. The costs to buy and sell would be too large.
One reader asked me how Vanguard approached the problem. The Vanguard bond ETFs, of course, are share classes of existing Vanguard bond mutual funds, which replicate their indexes. And so, the Vanguard ETFs share the same returns as those funds, holding effectively all of the securities in the underlying index.
How do they get around the creation/redemption problem? Creatively: they allow APs to do creation/redemptions with “optimized” baskets. Then, they round out the fund at the end of the day when the daily inflows/outflows for the mutual fund share classes occur. Clever…