4 ms·
How do bond ETFs work? I thought with stock ETFs they were convertible when you had a large number. This would keep the etf price in line with it's underlying
by acover 8y ago
How do bond ETFs work?
I thought with stock ETFs they were convertible when you had a large number. This would keep the etf price in line with it's underlying assets.
The issue with bond ETFs is I don't think the underlying bond is exchange traded. How would the conversion work?
I ask because this article has reminded me that I should probably diversify away from bond ETFs into GICs
- mabbo 8y agoMy understanding is that there are markets where bonds can be bought and sold. An ETF of bonds is just a large fund holding a set of bonds and trying to keep track of their current value. Since you know what the return on the bond is, at what price, interest rate and time, you can very easily assess the current value of a bond, especially compared to what you might make if you just bought GICs at the current rate. An interest rate hike today lowers the sell price of bonds purchased at yesterday's rate.
- acover 8y agoI think the market is still brokers talking. There is no centralized exchange. https://www.quora.com/Why-isn’t-there-a-bond-exchange-equivalent-to-the-NYSE https://www.quora.com/Why-isn’t-there-a-bond-exchange-equiva...
- dboreham 8y agoA bond ETF doesn't hold all the underlying bonds. Someone picks a subset and hopes they track the index.
- acover 8y agoThat can't be right. Vanguard lists the bonds that are in the ETF.
- tripletao 8y agoIt is right. Most bond ETFs (and some stock ETFs) buy only a statistical sample of the index, not the whole thing. It usually works fine. > For bond index ETFs, the sheer number of issues in their target indexes and the illiquid nature of many of these issues make full replication of the benchmarks prohibitive. Instead, most bond index ETFs replicate their benchmarks through a sampling approach. > Managers create samples that aim to match the fundamental characteristics of the bond indexes across such areas as: [...] https://advisors.vanguard.com/VGApp/iip/site/advisor/etfcenter/article/ETF_HowETFIndexed https://advisors.vanguard.com/VGApp/iip/site/advisor/etfcent...
- acover 8y agoAh, I agree with what you said. My question was about how closely it tracks an index but the underlying value of the bonds it holds. The article raises the possibility that illiquidity could cause the price of the ETF diverge from the bonds it holds.
- tripletao 8y agoIn fairness, that answer didn't directly address your question. The sampling approach helps a little with that liquidity issue, since the manager probably chooses a disproportionately liquid sample. But I don't see why people worry about divergence between the price of an ETF and the price of its illiquid holdings. The illiquidity is fundamentally there, and it's just a question of whether you expose it to the customer (like an ETF) or conceal it using stale prices, estimated prices, etc. (like a mutual fund).
- acover 8y agoThe article explains one issue is that the investors in bond ETFs have an unrealistic expectation of liquidity. When the ETF becomes illiquid and is dropping quickly, the conservative bond investor may rush to sell and cause the ETF drop significantly in price despite the underlying bonds still being sound.
- tanderson92 8y agoThe problem is usually stated in that the ETFs have a lot more liquidity than the underlying constituent bonds. This causes questions about what will happen if the market freezes up even more -- you might find wild deviations of ETF prices from NAV.