white papers

Fixed income ETFs: a liquidity illusion?

Fixed income ETFs: a liquidity illusion?
Anando Maitra, PhD, CFA - Head of Systematic Research and Portfolio Manager

Anando Maitra, PhD, CFA

Head of Systematic Research and Portfolio Manager
Jamie Salt, CFA - Systematic Fixed Income Analyst and Portfolio Manager

Jamie Salt, CFA

Systematic Fixed Income Analyst and Portfolio Manager
Maxim Lindqvist, CFA - Quantitative Research Analyst

Maxim Lindqvist, CFA

Quantitative Research Analyst

The assets of fixed income exchange-traded funds (ETFs) have increased rapidly since they first appeared in 2002, with a key advantage of superior liquidity based on higher trading volumes and low bid-ask spreads.

However, the events of the Covid-19 crisis exposed how key structural flaws in fixed income ETFs, which do not manifest in equity ETFs, severely hamper their functionality in periods of high market volatility

In this paper, we show that this ‘illusion of liquidity’ is paid for through significant tracking errors in stressed market conditions, as the price-NAV1 volatility for fixed income ETFs can be significantly higher than the NAV tracking error. Additionally, we find that the price-NAV dislocation is not just from NAV staleness, as proposed by ETF proponents, but might also constitute an over-reaction in prices, indicating that both may be “wrong”.

Furthermore, we believe that underlying asset liquidity is not the sole driver of these dislocations. As an outcome of post-global financial crisis regulations, the decreased warehousing of risk has contributed significantly to the fractured liquidity environment. We find that this reduced warehousing of risk has created a conflict in the dual role of the large dealers as both market-makers and authorised participant (APs). This may have led to the use of ETFs in inventory management operations, and exacerbated dislocations.


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Price-NAV refers to the difference between the secondary market price and the net asset value (NAV). The secondary price is the price accessible to investors, while the NAV is the value of the underlying assets.  

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