On March 23, in an effort to offer stability and improve liquidity in the corporate credit market, the US Federal Reserve (Fed) announced that it would begin purchasing individual bonds of US investment-grade-rated firms with a maturity of five years or less, as well as broad corporate bond ETFs. Bond and ETF shares will be purchased under the Federal Reserve Secondary Market Corporate Credit Facility (SMCCF), with $10 billion of capital allocated by the US Treasury.
The Fed’s goal of injecting liquidity into the corporate credit market can be supported by the use of ETFs, as they provide broad market access to a diverse set of firms through a single investment.
Notably, we do not view the Fed purchasing ETFs as a way to abate any perceived stress in the fixed income ETF marketplace. If that were the Fed’s goal, the scope of its purchase would be broader than a group of corporate bond ETFs that make up only 19% of fixed income ETF assets.1
Rather, we believe that the Fed is including broad investment-grade corporate bond ETFs within the SMCCF program because ETFs are:
Broad: Own many different credits across a wide array of industries and issuers. For example, the SPDR Portfolio Intermediate Term Corporate Bond ETF (SPIB) has nearly 4,000 individual bonds in its portfolio2
Flexible: Can be bought or sold on the secondary market or in the primary market
Transparent: For example, all SPDR Fixed Income ETFs disclose their holdings on a daily basis to all investors, with changes for rules-based funds documented in publicly disseminated rules (e.g., index methodologies)3
A stable asset base: Long-term investors use ETFs in strategic asset allocation frameworks, leading to little concern that the central bank could become a majority owner of the corporate bond ETF market
The Known Knowns
Similar to other stimulus actions in prior crisis periods, this program was announced pending full implementation details. For example, there are outstanding questions on the potential use of leverage to increase the stimulus provided. As a result, the size of the program has not yet been confirmed by policy officials. However, based on market insight4 and the fact that the Fed can lend roughly 10 times what it holds in collateral for non-government securities, the size of the program could be as large as $100 billion. Here’s what we know now about the ETF purchase criteria:
Eligible ETFs: Broad investment-grade corporate bond ETFs listed only in the US
Limitations: Will not purchase more than 20% of the assets of any particular ETF or purchase ETFs when they trade at prices that materially exceed the estimated net asset value of the underlying portfolio (i.e., a premium)
Duration of program: The SMCCF, at present, will cease purchasing eligible corporate bonds and ETFs no later than September 30, 2020
The Known Unknowns
Back-of-the-envelope math using the above constraint of being able to purchase only 20% of an ETF’s assets would indicate that roughly $30 billion of corporate bond fixed income ETF assets could be purchased.5 However, even that number may differ from what is in scope, as our calculations include all indexed-based funds focused on US bonds, some of which are likely too niche or narrow of a focus for consideration (e.g., rate hedged, ESG, specific year focused). There are two additional open items:
ETF selection process: The term “broad” leaves a lot to be determined. It could mean that the exposure needs to have all parts of the term structure (e.g., short, intermediate, and long term) or just that the ETF needs to hold a number of bonds. If it is the latter meaning, broad term-focused corporate bond ETFs that have thousands of holdings could be in consideration. It’s also unclear if there is a constraint on the asset levels in the ETF (i.e., whether the ETF must have over $100 million in AUM) or liquidity (i.e., trading volume).
Implementation phases: Will the purchases occur over multiple days and weeks, or be conducted via the secondary or primary market?
Despite all of this uncertainty, we can glean some potential ETF options that the Fed may use, based on our interpretation of the constraints as well as our ETF market insights.
The top 7 ETFs, by assets, that could be part of the purchase program are listed out by issuer below:
# of Holdings
SPDR Portfolio Short Term Corporate Bond ETF
SPDR Portfolio Intermediate Term Corporate Bond ETF
Vanguard Intermediate-Term Corporate Bond ETF
Vanguard Short-Term Corporate Bond ETF
iShares iBoxx $ Investment Grade Corporate Bond ETF
iShares Short-Term Corporate Bond ETF
iShares Intermediate-Term Corporate Bond ETF
Source: State Street Global Advisors, SPDR ETFs as of 03/27/2020.
As more details unfold, we will continue to assess implementation by the SMCCF and share our insights.
1 Based on any ETF listed as investment-grade corporate per Bloomberg Finance L.P., as of 03/27/2020. Calculations by SPDR Americas Research. 2 Bloomberg Finance L.P., as of 03/27/2020. 3 Depending on the issuer, some funds holdings may or may not be updated on a daily basis. 4 “The Fed’s new credit programs,” J.P. Morgan North America Credit Research, 03/23/2020. 5 Calculations are based on removing any active, non-US-focused corporate bond ETFs and then applying a 20% constraint to the current asset levels.
The views expressed in this material are the views of Matthew Bartolini through the period ended March 30th, 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.
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