The Financial Services Authority is concerned about liquidity in actively-managed corporate bond funds, but questions are being raised as to whether this affects exchange traded funds (ETFs).
The City watchdog sent a letter to groups with actively managed corporate bond funds in the summer, to see what risk controls and monitoring is in place to meet large-scale redemptions should they occur.
However, the construction of ETFs, the relative size of the industry and the inherent diversification mean that liquidity is not such an issue in these products.
The iShares Markit iBoxx £ Corporate Bond fund, one of the larger ETFs in this space, for example, has total net assets of £1.3 billion. But overall, estimates suggest European ETFs amount to only 3% of the European Ucits fund industry.
Aside from this, ETFs offer a couple of layers of liquidity, unlike actively managed funds.
‘When a client wants to buy or sell an iShare, there’s an order - you send it to people who want to buy on the secondary market – a place where there is a lot of liquidity,’ said Alex Claringbull, senior fixed income portfolio manager at iShares, BlackRock.
‘If this is not the case, the iShare can be redeemed with the manager, who can then sell the bonds and raise the cash.’
In contrast, active managers have no secondary market in open-ended funds, and they can only sell back units to the manager.
‘So ETFs have an extra layer of liquidity, which also implies lower transaction costs, through a tighter bid-offer spread,’ said Claringbull.
‘Also investors like how there is a market, so it’s not just you and the manager. The secondary market means there are multiple investors, with price discovery and transparency,’ he added.
Furthermore, a large active manager can have significant concentrated holdings, whereas an ETF is generally more diversified, and has many more positions.
‘The conundrum for active managers is the more money that goes into the fund, the bigger the concentrated active positions become,’ said Claringbull.
He warned that liquidity in the corporate bond space is a big issue, since 2007 and 2008. ‘Fixed income liquidity is significantly down because the big investment banks are pulling capital away from trading activities,’ he added.
Aside from the dual liquidity offered by ETFs, investors should also take into account the position of the product provider.
Large providers such as banks, for example, can do a significant amount of internal crossing. This means if the ETF needs to buy or sell, the provider can look for buyers or sellers internally, before going out to market.
‘The size of BlackRock really does help, when it comes to the clients redeeming,’ said Claringbull. ‘There are a lot of internal crossing opportunities and if we exhaust these, and if we have to go to market, we’d likely be the preferred client of all these banks, who want to work with us to access pools of liquidity.’