High Yield ETFs Surge in Frozen Markets

Performance post-downgrade makes case for liquidity sleeves.

August 15, 2011

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story_images_ice-cub-trayMy most recent blog post on the Benefits Canada ETF Resource Centre explores two different realities in the high yield market that played out in the wake of the US debt downgrade. While the high yield debt market essentially froze, high yield ETFs experienced record volume. Read below to find out what it means for investors and plan sponsors:

High yield bonds have been good to yield-hungry investors in recent years. In fact, 2010 was one of the best years on record for the asset class.

This month, though….not so much.

In the wake of the U.S. downgrade by S&P, the high yield market experienced a sharp turnaround: high yield debt essentially stopped trading on both August 5th and August 8th as investors ran away from risk assets.

For plan sponsors keen to move at least part of their high yield portfolio, it meant they were stuck in an illiquid market.

But there was one bright spot: high yield ETFs experienced record liquidity while the rest of the market stopped trading for two days.

Here’s how it played out. On August 5th, when the US high yield over-the-counter market was basically frozen due to lack of liquidity, the iShares iBoxx $ High Yield Corporate Fund (HYG) had a volume of 4.6719 million shares.

Then, on August 8th, when liquidity was still too thin for comfort in the US high yield market, HYG’s volume spiked to 6.4915 million shares.

At least something was moving in the high yield space.

I’ve written before about ETFs as an escape hatch in illiquid markets. Because they tend to be a lot more liquid than the underlying asset class, adding a layer of ETFs to a portfolio means you have a bit of wiggle room when markets freeze up.

And given the fact that markets probably haven’t finished punishing policymakers for their dithering in Europe and the US, an ETF escape route is starting to look better every day…

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