Perennially Strong Liquidity
HYG never seemed to have a liquidity problem. The fund, which today trades on average more than $1 billion every day, does so at a penny spread. That’s an attribute of the structure itself, Laipply says.
“There are a lot of misconceptions surrounding ETFs. Oftentimes, there's a narrative that during periods of market stress, you can have forced inflows or outflows, and that's simply not the case,” he said.
According to him, even in periods of market stress in the bond market, investors will still be able to trade HYG on exchange, away from the bond market itself. “It's a layer of additional liquidity that exists that's not present in other instruments.”
Most of HYG's trading happens on the stock exchange, but the underlying doesn't have to be actually traded in the bond market.
“We've observed during periods of market stress that the amount that's traded on exchange relative to the bond market through creation/redemption process actually increases,” said Laipply.
If you look back, for example, to December 2015, when there was a fairly pronounced risk-off market in high yield, HYG traded more than $30 billion for the entire month. At the same time, the amount of net redemptions was around $1.5 billion, so the ratio of volume that cleared on exchange away from the underlying market was roughly 20-to-1, he notes.
Trading Cost Benefits
Trading HYG is cheaper than trading an actual high-yield bond. According to iShares data, you get a 1 basis point bid/ask for the ETF versus 50 basis points for individual bonds. Laipply says that’s due to several reasons.
In his words: “in order of progression, you have a portfolio bond and a portfolio itself will trade differently than individual bonds. You then add to that the idea of transparency and a rules-based exposure, so the bonds enter and leave HYG based on specified rules according to the index that it tracks. You then have the ability to see all of the holdings in HYG daily. Those attributes alone would allow for greater comfort around trading, and therefore compress the bid/ask spreads.”
Finally, you also have different places to trade: the exchange, which is the primary venue; and the over-the-counter markets; or creation/redemption, which allows the portfolio and exchange to stay anchored to the value of the underlying bond.
All of these factors allow for this huge compression in trading cost.