Virtu Financial, one of the world’s largest electronic market makers says it won’t touch bond ETFs because they are too hard to trade. Bond ETFs have become increasingly popular over recent years. Many individual investors have been flocking to bond ETFs. They are a major component of robo-advisor portfolios. Bloomberg reports that assets have increased five-fold since January of 2010 to about $600 billion.
So why is one of the world’s largest traders avoiding this booming market? From Bloomberg:
One of the world’s largest electronic market makers won’t touch increasingly popular exchange-traded funds tied to bonds because the underlying securities are too hard to trade.
Readily available access to the underlying securities in ETFs is necessary to enable the funds to function properly. Virtu’s CEO says
“It’s definitely concerning you don’t have full and unfettered access to the underlying,” Cifu said, speaking at a Security Traders Association conference in Washington on Thursday. “That’s troubling.”
When the underlying bonds can’t easily be purchased and sold by market-markers in bond ETFs, they start to trade at wide premiums and discounts from their underlying values. Bond ETF investors who aren’t careful may end up paying premiums of as much as 2%.
In a low rate environment where every basis point counts, paying 2% more for a bond ETF than it is worth and selling it for 2% less than it is worth can wipe out years of interest income.
At Young Research, we continue to favor an individual bond securities first approach. For those lacking the funds to craft a diversified bond portfolio, we advise open-end bond mutual funds over bond ETFs. Bond ETFs have a role to play in certain situations, but only a very limited role.
Jeremy Jones, CFA
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