How Illiquid Are Bond ETFs, Really?

November 24, 2015

[Editor's Note: An earlier version of this blog attributed the phrase "transcendant liquidity" to BlackRock. In fact, that phrase came from CEO Matt Hougan. We apologize for the error, and Matt apologizes for his unnecessary poesy.]

“Transcendent liquidity” is a somewhat silly-sounding phrase coined by the equally silly Matt Hougan, CEO of, to discuss the odd situation in fixed-income ETFs—specifically, fixed-income ETFs tracking narrow corners of the market like high-yield bonds.

But it’s increasingly the focus of regulators and skeptical investors like Carl Icahn. Simply put: Flagship funds like the iShares iBoxx High Yield Corporate Bond ETF (HYG | B-68) trade like water, while their underlying holdings don’t. Is this a real problem, or a unicorn?

Defining Liquidity

The problem with even analyzing this question starts with definitions. When most people talk about ETF liquidity, they’re actually conflating two different things: tradability and fairness.

Tradability is actually a pretty simple concept: How well will the market let me get in or out of an ETF? And for narrow fixed-income ETFs (I’m limiting myself to corporates, in this analysis), most investors should be paying attention to the fairly obvious metrics, e.g., things like median daily dollar volume and time-weighted average spreads. By these metrics, a fund like HYG looks like the easiest thing to trade ever:

On a value basis, the average spread for HYG on a bad day of the past year is under 2 basis points. It’s consistently a penny wide on a handle around $80, with nearly $1 billion changing hands on most days. That puts it among the most liquid securities in the world. And that easy liquidity is precisely what has the SEC—and some investors—concerned.


But that’s tradability, not fairness. Fairness is a unique concept to ETF trading. We don’t talk about whether the execution you got in Apple was “fair.” You might get a poor execution, or you might sell on a dip, but there’s no question that your properly settled trade in Apple is “fair.”

That’s because Apple stock is always worth precisely what you pay for it. That’s the entire function of the market—to determine the fair price for Apple based on the collective wisdom of buyers and sellers.

Of course, even Apple can get a bad print, and there are rules for breaking really erroneous trades, but for the most part, if Apple’s down 10%, nobody considers it anything other than a bad day for Apple.

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