“We” applaud the creation of Exchange Traded Funds as a low cost and liquid way for investors to achieve portfolio diversity. We then apply the concept to highly illiquid asset classes and explode their usage whereby the funds themselves are trading at dozens of multiples of the underlying assets. This enables enormous new issuance as sellers “think” they have automatic buyers for their bonds. We then wring our hands at the first crisis of liquidity whereby the obvious reveals itself: the liquidity of the underlying assets is woefully under that of the funds. We then have the Feds come in and buy ETFs. Maybe Elizabeth Warren is right? (Insert choke here.)
From the May 30th Wall Street Journal:
The Federal Reserve’s first $1.3 billion of purchases of exchange-traded funds that invest in corporate bonds show that funds that focus on buying non-investment grade debt accounted for around one sixth of the central bank’s ETF purchases.
The Fed announced plans to backstop debts of investment-grade firms after the coronavirus pandemic led to a deep freeze across credit markets in mid-March, and it subsequently said in April it would backstop debt for so-called fallen angels, or firms that had been rated investment grade as of March 22 but were subsequently downgraded to junk status.
As part of the backstops, the Fed on May 12 began purchasing exchange-traded funds that provide broad exposure to U.S. corporate bond markets. The Fed said the “preponderance” of those holdings would be in funds whose primary investment objective was in the market for debts with investment-grade ratings, but officials said they would allow for some purchases of ETFs with exposure to junk bonds.
The decision to invest in junk debt has been controversial. Some investors have argued that the central bank risked a deeper credit freeze that would lead to higher unemployment if the central bank shunned riskier assets, while others warned that doing so would reward firms and their investors that were already vulnerable to an economic downturn before the crisis due to heavy debt burdens.
The disclosures of 158 transactions cover purchases made between May 12 and 18. Of the Fed’s $1.3 billion in ETF holdings as of May 19, around 17% were in funds that invest primarily in junk debt. The funds the Fed invested in have appreciated 2.7% on average since purchases began on May 12, according to Roberto Perli of Cornerstone Macro, a research firm.
