The average discount on fixed income ETFs, across the industry, has widened to levels not seen since the financial crisis1. While some may view this as an issue with fixed income ETFs, structurally this is what we’d expect because investors are using ETFs as price discovery tools. The discount simply reflects the fair market price between willing buyers and sellers based on their assessment of the valuation of the underlying bonds – some of which may not have traded recently.
NAV pricing can be stale in a volatile market At its most basic level, an ETF’s NAV reflects an estimate of the value of an ETF's underlying portfolio. Typically, that NAV is likely to be fairly accurate. However, in a volatile market, like today’s, difficulties in pricing and trading fixed income securities will impact the estimate of the fair value of that basket of bonds. When underlying fixed income market liquidity becomes constrained, pricing becomes increasingly opaque. And individual bond pricing can lag real-time market sentiment as well as realistic pricing levels.
Real-time sentiment, however, will show up in fixed income ETF market prices on where the market deems that basket of bonds should trade, based on prevailing macro information and the assessment of risk.
There are also structural factors that can lead to wider than normal premiums and discounts during periods of volatility. Fixed income NAV prices are typically struck as of 3 p.m. EST – and ETF trading that continues from 3 to 4 p.m. can lead to distorted premiums/discounts relative to those NAVs struck at 3 p.m. Importantly, we have recently seen plenty of market-moving news break well after 3 p.m. that has impacted the level of a fixed income ETFs discount, as the market is incorporating real-time news while the underlying market is closed. This is the ETF acting as price discovery tool.
ETFs remain at least as liquid as their underlying constituents The other structural aspect is that the large discounts in fixed income ETFs are likely reflecting market participants inability to trade underlying bonds at levels reflected in (potentially stale) NAV valuations. Therefore, as stated above, the ETF’s price may better reflect actionable prices to trade constituents.
Further, despite higher relative ETF trading volumes – fixed income ETFs traded a record $47 billion on February 28, only to break that record on March 9 with $53 billion, and have traded three times their normal daily volume from February 21 to March 17, 2020 compared to the same period in 2019,2 – we have not seen a large uptick in primary market activity. This could further indicate that underlying market liquidity is not being properly reflected by NAV pricing sources.
Focus on Execution Strategies
With fast-moving markets and uncertainty related to underlying pricing, ETF execution strategies become more important. We continue to advise that investors trading any ETF should:
Use limit orders, not market orders.
Avoid the market open (first 30 minutes of trading).
Avoid the market close (up to last hour of trading).
Work with your respective execution desk or liquidity provider to source liquidity not displayed on screen.
As we’ve seen in other periods of stress, ETF volumes have spiked as investors have gravitated to the transparency of exchange trading to make real-time asset allocation decisions and source liquidity at a time when they demand it most. And we encourage investors to contact us with questions and for guidance.
1 Bloomberg Finance L.P. as of March 17, 2020 calculations by SPDR Americas Research 2 Bloomberg Finance, L.P., as of March 17, 2020
Net Asset Value (NAV) The value per share of a mutual fund or an exchange-traded fund (ETF) on a specific date or time.
The views expressed in this material are the views of Matthew Bartolini and Bruce Salzman through the period ended March 18th, 2020 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Investing involves risk including the risk of loss of principal. Past performance is no guarantee of future results.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without State Street Global Advisors’ express written consent.
ETFs trade like stocks, are subject to investment risk, fluctuate in market value and may trade at prices above or below the ETFs net asset value. Brokerage commissions and ETF expenses will reduce returns.
Standard & Poor's®, S&P® and SPDR® are registered trademarks of Standard & Poor's Financial Services LLC (S&P); Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC (Dow Jones); and these trademarks have been licensed for use by S&P Dow Jones Indices LLC (SPDJI) and sublicensed for certain purposes by State Street Corporation. State Street Corporation's financial products are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates and third party licensors and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability in relation thereto, including for any errors, omissions, or interruptions of any index.
Distributor: State Street Global Advisors Funds Distributors, LLC, member FINRA, SIPC, an indirect wholly owned subsidiary of State Street Corporation. References to State Street may include State Street Corporation and its affiliates. Certain State Street affiliates provide services and receive fees from the SPDR ETFs. ALPS Distributors, Inc., member FINRA, is the distributor for DIA, MDY and SPY, all unit investment trusts. ALPS Portfolio Solutions Distributor, Inc., member FINRA, is the distributor for Select Sector SPDRs. ALPS Distributors, Inc. and ALPS Portfolio Solutions Distributor, Inc. are not affiliated with State Street Global Advisors Funds Distributors, LLC.
THIS SITE IS INTENDED FOR QUALIFIED INVESTORS ONLY.
No Offer/Local Restrictions
Nothing contained in or on the Site should be construed as a solicitation of an offer to buy or offer, or recommendation, to acquire or dispose of any security, commodity, investment or to engage in any other transaction. SSGA Intermediary Business offers a number of products and services designed specifically for various categories of investors. Not all products will be available to all investors. The information provided on the Site is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation.
All persons and entities accessing the Site do so on their own initiative and are responsible for compliance with applicable local laws and regulations. The Site is not directed to any person in any jurisdiction where the publication or availability of the Site is prohibited, by reason of that person's nationality, residence or otherwise. Persons under these restrictions must not access the Site.
Information for Non-U.S. Investors:
The products and services described on this web site are intended to be made available only to persons in the United States or as otherwise qualified and permissible under local law. The information on this web site is only for such persons. Nothing on this web site shall be considered a solicitation to buy or an offer to sell a security to any person in any jurisdiction where such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction.
Before investing, consider the funds' investment objectives, risks, charges and expenses. To obtain a prospectus or summary prospectus which contains this and other information, call 1-866-787-2257, download a prospectus or summary prospectus now, or talk to your financial advisor. Read it carefully before investing.
Not FDIC Insured * No Bank Guarantee * May Lose Value