No Big Deal
This is, as I said, the biggest—and we assume most liquid—position in the fund, and has changed hands just 655 times in 2018. So far in our very interesting December, it’s traded 30 times, for a total volume of 21,055 bonds traded at around par of $1,000, so around $21 million changing hands.
This is, to be blunt, not a lot in the grand scheme of things. Over the course of this year, about $1 billion has changed hands out of an issuance of some $3 billion for this particular note. It also often goes days with no trades at all. And this is the largest position in the fund. The least-liquid floaters in the portfolio haven’t even traded in the past week or so.
So it’s really no surprise when you see a disconnect between the “price” of these bonds and the price of the ETF that holds them. This potential disconnect is even bigger if there are any flows—which there have been. Here’s the premium/discount in concert with the actual flows into FLOT:
Here you can see the four days of negative flows that coincide with the perceived discount in the trading price of the ETF. Again, this is pretty normal for a fund holding less-liquid securities that has big outflows (in this case, a reaction to the action in the yield curve last week).
ETFs Working As Designed
What this isn’t, however, is a sign that somehow the ETF is broken. This is the ETF acting as price discovery for the market. The correct way to look at the chart above is that the action in the ETF—where there’s a lot of liquidity—acted to “set” the price of the underlying. And sure enough, the trading prices of the bonds came down in reaction.
But the other thing I feel obligated to point out is that this chart completely misrepresents the magnitude of what’s happening precisely because the value of FLOT versus its holdings has been so stable for so long.
At the worst of this, the trading in FLOT drove it to a whopping 0.60% below fair value.
Compare that to how other funds holding less liquid bonds fare on a regular basis:
This is the SPDR Bloomberg Barclays High Yield Bond ETF (JNK)—one of the bigger trading vehicles for junk bonds. Over the course of the last year, it’s swung from similar premiums and discounts in response to flows, and nobody loses their mind over it—investors just get that this is how this part of the market works.
Or consider the municipal bond ETF space and the VanEck Vectors High-Yield Municipal Index ETF (HYD):
Charts source: Bloomberg
Here a few days of redemptions drove the perceived discount to over 1%, and lo and behold, the ETF served—again—as price discovery, essentially “pulling” the price of the underlying bonds down to where the real trading was happening.
These moves in the less-liquid corners of the market are far from a crisis. Instead, these are precisely where these funds are designed to provide a real service to investors.
Or to put it in the sarcastic words of Br’er Rabbit: “Born and bred in the briar patch, Br’er Fox. Born and bred.”
Dave Nadig can be reached at [email protected]