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Amid market turmoil spurred by pandemic concerns, investors increasingly turned to bond exchange traded funds (ETFs) for clarity about what was happening in fixed income markets and to actively adjust their portfolios. Recent evidence confirms that bond ETFs can accurately reflect the conditions of the markets while improving price transparency and providing access to liquidity in periods of market stress.

Commentators have long speculated about what would happen should bond ETFs be tested by a once-in-a-generation market shock and raised questions about whether ETFs can withstand waves of selling. The facts from February and March 2020 show that ETFs held up well in extreme fixed income market conditions. Investors turned to the most liquid bond ETFs to help them navigate bond market dislocations. As they did so, these flagship ETFs became sources of real-time price discovery for markets where transparent quotations and trading activity deteriorated.

As bond markets get more volatile, investors flocked to bond ETFs

As financial market volatility increased from late February through late March 2020, average daily trading volumes in all U.S. bond ETFs more than tripled to nearly $35 billion, compared with $11 billion last year.1

Investors tend to use bond ETFs even more during times of uncertainty because they are efficient and effective tools for rebalancing holdings, hedging portfolios and managing risk. Consider the following:2

  • Daily trading volume in the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) surged to more than $8 billion (compared with an average of $1.7 billion in 2019) on the same day that the Cboe Volatility Index, or VIX, climbed to its highest level since 2011.
  • By itself, HYG accounted for 27% of total high-yield bond market trading over this four-week period. That’s up from 14% in January.

Whether in HYG or other ETFs that seek to track bond indexes, the implication is clear: as markets became more volatile, investors flocked to bond ETFs.

ETF trading jumps in line with market volatility

Graph is showing HYG secondary volume vs. Cboe Volatility Index from January 2019 until January 2020.

Source: BlackRock, Bloomberg (data as of March 24, 2020)

As more investors turned to bond ETFs, they became indicators of real-time prices

Bond ETFs trade frequently, meaning their prices incorporate more real-time information than even the most heavily traded bonds in the fund. This is especially true during volatile markets as ETF trading activity increases.

On March 12, one of the worst days for U.S. stock benchmarks in modern history, shares of the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) changed hands almost 90,000 times on exchange, while its top five holdings traded an average of only 37 times apiece.3 Throughout March, more than half of LQD’s bonds traded between zero and five times per day, on average.4 ETFs regularly trade thousands of times more frequently than the bonds in their portfolios, a pattern that is magnified in volatile markets. Consider that of the more than 21,000 publicly registered corporate bonds, for example, fewer than 1% trade daily in the over-the-counter market.5

Each day U.S. ETFs are required to publish a net asset value (NAV), or the estimated fair value of its holdings. For bond ETFs, NAV is based on both actual trades and estimates based on trades of similar bonds from the same issuer or sector, or other market metrics. Unlike NAV, a bond ETF’s on-exchange price represents an actionable trade for that entire portfolio at that moment. This price can differ from NAV, particularly during periods of volatility and market stress.

Indeed, bond NAVs can at times resemble appraisals for a home, which are similarly derived from both real trades in the neighborhood as well as estimates. As any homeowner knows, the difference between an appraisal price and the closing price can vary markedly: the price that matters is the one at which you can buy or sell.

When a bond ETF trades at a “discount” or a “premium” during volatile periods, the takeaway is often that ETFs offer real-time price indications much like closing prices for a home represent levels where real buyers meet real sellers.

How often did LQD index holdings trade during a volatile March 2020?

Graph is showing the trading activity for the LQD universe during March 2020.

Source: FINRA TRACE, BlackRock from 3/2/2020 - 3/20/2020. Includes only end investor buys and sells - not dealer-to-dealer trades.

Bond ETFs have performed as expected

Investors ultimately use index-tracking bond ETFs to seek index performance. Many of the most liquid iShares bond ETFs delivered this, even in the face of extreme volatility. And recent market volatility has not impacted longer-term index tracking. Performance and tracking information for every iShares ETF is available every day for all investors.