![ETFs transforming the junk space](https://www.benefitscanada.com/wp-content/uploads/sites/7/2012/01/wreck-car-junk.jpg)
A few weeks ago, I moderated a panel of DB plan sponsors discussing investment trends in Canada. As the group shared their views on volatile equity markets and mounting economic risks, one plan sponsor made a simple yet key point: “If interest rates would just go up, a lot of our risks would just disappear. We wouldn’t have these problems.”
If only.
The impact of low interest rates is painfully obvious to sponsors of DB plans not just here in Canada but around the world. With rates set to stay stubbornly low, especially with disappointing numbers coming out of the U.S. last week, plan sponsors have had to expand their horizons considerably, particularly on the fixed income front as they search for higher yields in a low rate environment.
One area that has seen a lot of interest from institutional investors – and pension funds in particular – has been the high yield bond space. Also known as “junk” bonds, performance in high-yield has been quite good rates on traditional bonds like Treasuries have been awful.
But there is a problem. As interest in corporate credit grows, dealers don’t have the products on hand to supply the increasing demand according to Reuters. That has pushed all that institutional cash into ETFs that own high-yield bonds – for example, says Reuters, institutions own 51% of BlackRock’s high yield ETF while 60% of State Street’s is owned by institutions.
It means institutions are bypassing dealers altogether and moving straight into the high-yield via ETFs.
The big draw for many investors is liquidity – “Liquidity is the main reason that we’re using high-yield ETFs right now rather than high-yield bonds,” Tim Anderson, chief fixed-income officer at RiverFront Investment Group LLC in Richmond, Virginia told Reuters.
“In the good old days you could call up one of the major firms and there’d be a halfway decent shot you could sell $15 million, $30 million of bonds to them on the line,” said Anderson, whose firm is the sixth-biggest institutional shareholder in State Street’s fund. “They’re not keeping the same inventories anymore.”
Bank dealers, for example, will continue to shed their junk bond inventories especially in the wake of global limits on risk taking post-2008.
As this happens, ETFs will likely continue to push aside dealers as the go-to place for exposure to many corporate credit products including high yield.