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Yes, This Junk Bond ETF Is Sufficiently Liquid

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Yes, This Junk Bond ETF Is Sufficiently Liquid
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Arguably the biggest source of controversy surrounding high-yield bond exchange-traded funds has been the ability of these products to remain sufficiently liquid during times of elevated market duress. With size and liquidity being important factors to many professional investors, that might be why so many pros turn to the iShares iBoxx $ High Yid Corp Bond (ETF) (NYSE: HYG) and the SPDR Barclays Capital High Yield Bnd ETF (NYSE: JNK) for junk bond exposure via ETFs.

Junk Bond Liquidity

A recent study by Fitch Ratings confirms that an issue's size and ratings were pivotal factors in determining junk bond liquidity.

HYG and JNK are the two largest high-yield corporate bond ETFs in the United States, in addition to being the most heavily traded. A big part of the reason ETFs like HYG and JNK are able to allay liquidity concerns is the secondary market.

Related Link: Despite Risks, Investors Flock To Junk Bond ETFs

The Importance Of Secondary Markets For Junk Bonds

The secondary market for junk bonds and ETFs like HYG and JNK is vital because during times of heightened market stress, over-the-counter high-yield bond market liquidity can and does evaporate, forcing the bulk of trading into the largest, most liquid issues.

As was seen during the taper tantrum of 2013, the secondary market for ETFs bolsters available fixed income market liquidity and can act as an efficient price discovery mechanism for the issues held by a fund such as HYG and JNK.

During December's volatility spike, JNK provided investors with a liquid away for moving in and out of junk bonds. Data confirm as much.

“JNK traded on average $769 million a day, an 87 percent increase over the previous 90 days,” said State Street Global Advisors in a recent note. “The abundance of liquidity was provided at bid/ask spreads (0.03 percent) similar to the prior 90 days.”

Related Link: Jumping For Junk: High-Yield Bond ETF Volume Rises

Another data point from State Street underscores the importance of the secondary market for junk bond ETFs. During that period of elevated market stress in December, $2 of every $3 that changed hands in JNK did so on the secondary market.

“Due to an ETF’s unique in-kind creation/redemption process where a representative basket of the portfolio is delivered to the exiting participant in exchange for shares of the ETF, JNK was not a forced seller of bonds in the market. Even during this period of market disruption and perceived illiquidity, the ETF structure delivered on its promise and provided investors with an efficient mechanism for obtaining high yield exposure,” added State Street.

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