Credit Cold = ETF Pneumonia

wsjlogoCourtesy of WSJ Matt Wirz

Corporate bond exchange-traded funds attracted investors in record numbers during the credit bull run of the past three years. They also attracted criticism for trading with more volatility than the bond markets they were designed to track. With the selloff in Treasury bonds rattling credit markets, those concerns are proving well founded.

BlackRock’s iShares iBoxx $ Investment Grade Corporate Bond Fund has delivered a one-month total return of negative 2.98%, according to Morningstar. That compares to a total return of negative 2.06% for the widely followed Barclays Investment Grade Corporate Bond Index. An index of more liquid investment grade bonds run by iShares delivered a negative 2.67% return over the same period.

The higher volatility of the ETFs in softer bond markets reflects the “inherent limitations of the ETF investment vehicle,” says James Lee, a senior analyst covering high yield at Calvert Investment Management Inc.

Because ETFs cannot hold large cash positions to cushion market swings, they become forced sellers of bonds when investors sell out and forced buyers when investors buy new shares. That dynamic lends itself to heightened ETF volatility in bond markets where securities trade less often, and with wider bid-ask spreads, than exchange-traded stocks and commodities.