On Monday, March 23, as part of extensive measures to shore up the credit markets, the Fed made the unprecedented announcement that it will purchase investment-grade corporate bond ETFs. The Fed then announced that BlackRock will serve as the investment adviser for several of the buying programs, including the ETF buying program. A few days later, we learned the details of the agreement between BlackRock and the NY Fed. So, let us delve into the details a bit further:
Pertinent details of the ETF buying program:
- Buy only US-listed ETFs which “provide broad exposure to the market for U.S. investment-grade corporate bonds.”
- Cannot own more than 20% of the assets of any particular ETF (as of Mar. 22)
- Avoid purchasing ETFs when they “trade at prices that materially exceed net asset value of the underlying portfolio”
- The current program to stop all purchases no later than Sep. 20 (unless renewed).
Pertinent details of BlackRock’s agreement with the NY Fed:
- Strict information barriers: “BlackRock staff assigned to this engagement will be segregated from other BlackRock engagements and activities.”
- BlackRock will rebate any fees earned on iShares (including sec. lending)
- If the share of iShares funds in the facility exceeds outstanding market share, BlackRock has to notify the NY Fed for review and consultation.
- ETFs should only be used “if their purchase is reasonably expected to achieve the purposes of the Facility more effectively than the purchase of underlying bonds.”
- Not surprisingly, daily reporting of all inventory, trading, and risk assessment, with periodic public disclosure.
Open Questions (and answers)
- What does “materially exceed NAV” mean?
I’m going on the simplistic assumption that buying ETFs at ANY premium will bring hellfire raining down on this program. While bond nerds like me could in good faith explain that “bid-asks were wide, and the ETF was good value, blah blah blah”, any whiff of enriching ETF asset managers and buying ETFs above NAVs is too high a reputational price to pay, and in any case, there is a part of the bond-buying program where the Fed can buy new issues, which in fact are at Bid price.
- What does “reasonably achieve purposes… more effectively than the purchase of underlying bonds” mean?
Simply, I think this just gives BlackRock some discretionary room for intelligent trading decisions. But in theory, it means the same thing as the previous stipulation – if bonds are cheaper (and available) to buy outright, buy the bonds directly, and if the ETF is cheaper, buy the ETF. But it could also point to something that my friend David Mann pointed out in an excellent article: that some ETFs may have greater impacts on underlying bond valuation than others based on primary activity (I will leave this discussion for another article).
Market Reaction:
As I posted, , it took no time for funds to react to this announcement. The big IG ETFs all jumped +5-7% and erased any whiff of a discount. The charts below show the immediate response of the five largest corporate ETFs pre and post the announcement.
Price Action of Five Largest Corporate ETFs around March 23. (normalized)
Discounts turn into Premiums after the Fed announcement:
Which ETFs might BlackRock buy for the Fed’s Corporate Credit Facility:
- Let’s narrow down the US Fixed Income ETF universe to determine what might be purchased for the facility. Number of US Bond ETFs above $10M: 358
- We need ETFs that have enough assets and trading volume to support significant activity, so for simplicity sake, I’m going to make a bold cutoff at $200M in assets: ETFs Remaining: 174
- Of these, remove funds not focused on Corporates: ETFs Remaining: 34
- Given the mandate on “Broad exposure,” lets exclude all manner of target-date, floating rate, hedged, optimized, and ultrashort funds. ETFs Remaining: 17
- And while David’s article makes an excellent case that Index and Active funds should be included in the mandate, I suspect that including Active ETFs is just one too many cans of worms to open (Can 1: Fed buys corp. bonds, Can 2: Fed buys ETFs of corp. bonds, Can 3: Fed asks BlackRock to buy ETFs of corp. bonds, Can 4: BlackRock buys ETFs that endorse a specific active strategy…result: overrun by worms!!)
ETFs Remaining: 13
Let’s reveal our “lucky thirteen” candidates, with some relevant statistics (as of March 27):
Conclusion: Simply by valuation, very few of these funds are currently in the territory of being buyable into the facility. I will refrain from naming funds and allow you to draw your own conclusions from the data above, namely the % Premium as compared to the previous 2-year average, and the average daily volume (ADV). Note that low ADVs make it very difficult for a trader to execute on a large buy without jolting the market. In a sense, the impact of the announcement made most of the funds ineligible for immediate buying into the facility due to valuation.
It will be very interesting to see the first few public reports on the Facility’s ETF buying activity and matching them up to reported volumes, fund flows, and premium % valuations. …Stay tuned…
HIGH YIELD UPDATE on MAY 1st:
(https://lnkd.in/gtCVU2c)
Data sources: YCharts, ETFLogic.com, ETFdb.com.
Reference Links:
Fed Primary Market Corporate Credit Facility
Fed Secondary Market Corporate Credit Facility
Terms of Agreement between BlackRock and NY Fed
Also two great articles by David Nadig on the topic: Fed Buying Bonds and Dear Larry.
Data sources: www.etfdb.com and Bloomberg.
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Elya Schwartzman is the founder and president of ES Investment Consulting LLC (ESIC), an independent consulting firm specializing in ETFs, fixed income, indexing, and investment infrastructure.
Disclaimers: Any opinions or views in this post should be assumed to be written by a cabin-fever-crazed lunatic, with access to far too much data, a rudimentary knowledge of excel, and no fact-checking or compliance department whatsoever. Caveat Emptor!
ESIC may now, or in the future, provide advisory services to companies in the ETF ecosystem.
