August 14, 2013 / 5:57 PM / 4 years ago

ETFs make inroads in bond market, outpace dealer inventories-Fitch

NEW YORK, Aug 14 (Reuters) - Exchange-traded funds are playing a bigger role in the U.S. fixed-income market as investors have flocked to corporate bond ETFs at the same time that dealers slash inventories, according to a Fitch Ratings report released Wednesday.

The five largest investment-grade corporate bond ETFs totaled about $46 billion in assets at the end of June, compared with dealer inventories of about $9 billion, according to the report.

The rising interest in ETFs comes as dealer holdings of corporate bonds have dwindled over the past few years, as banks become more risk-averse and regulatory capital weightings have discouraged the warehousing of large positions.

For high-yield corporate bonds, ETF assets totaled about $28 billion, or roughly four times the $7 billion in dealer inventories.

Trading activity of high-yield corporate bond ETFs also climbed on increased market volatility in late May, the report noted, showing that investors are using ETFs to “rapidly enter and exit fixed-income positions during a period of market turbulence.”

Average daily trading volumes for the five largest high-yield corporate bond ETFs more than tripled to more than $1.5 billion in early June, from about $470 million in early May.

That increased trading volume, however, could amplify overall bond market volatility, the report warned, as redemption of ETFs can in turn drive selling in the underlying bonds.

ETFs track a basket of securities, such as bonds, and can be traded in real time on exchanges like stocks. They offer access to indexes without having to buy the individual underlying holdings.

The Fitch analysts cited research from the Federal Reserve Bank of New York indicating that liquidation of more than $250 million in corporate bonds in one day by an investor or dealer could begin to adversely affect bond prices.

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