Extremely volatile conditions across the US fixed income market because of the coronavirus pandemic have led to a highly unusual pricing dislocation in Vanguard’s $55bn total bond market exchange traded fund, one of the world’s largest ETFs.
The ETF, known by its ticker BND, saw the gap between its closing price and the net asset value of the fund surge to a 6.2 per cent discount on March 12. Most ETFs usually trade throughout the day in a very narrow band around the NAV of the fund.
Since its launch 13 years ago, BND’s closing premium has averaged 0.17 per cent. Fixed income ETFs generally trade at a slight premium to NAV but many have switched to a discount this month over concerns that companies will struggle to service debt payments because of disruption caused by the coronavirus outbreak.
But Rich Powers, head of ETF product management at Vanguard, the world’s second-largest asset manager after BlackRock, said it was “not unusual” to see this type of divergence in stressed market conditions. “Market prices for ETFs can move more rapidly than the net asset value. That is part of the price discovery process.”
The discount for BND had narrowed to 1.5 per cent by the close on Monday.
Steve Zamsky, an executive at Smith Capital and former head of US credit trading at Morgan Stanley, said: “ETF vehicles held up well until about 10 days ago, but then the NAV gaps started opening up, and they’ve been persistent ever since. It shows the challenges that are out there. Liquidity has been really, really rough, and subsequently there’s a lot of pressure in ETF land.”
BlackRock runs a directly competing ETF known as AGG. The discount for AGG widened to 4.43 per cent on March 12 and has since narrowed to 1.44 per cent.
“Market makers are having to be extremely cautious in assuming and pricing risk in these challenging conditions. No one really has any clear idea about the pricing of some of the bonds held by these ETFs,” said Ben Johnson, director of passive funds research at Morningstar, the data provider.
Vanguard is one of the world’s largest bond managers and prides itself on the efficiency of its fixed income operations. The Pennsylvania-based group relies on an independent third-party provider to calculate the NAV of its fixed income ETFs using completed bond trades.
The closing price of the ETF is based on quotes from a wide range of market makers. It also reflects an assessment of the liquidity of the bonds held in the ETF by market makers.
“ETF market makers face uncertainty around the fair value of the bonds and how long they might have to hold them for while they wait for investors to trade. The market makers are pricing liquidity, and liquidity has a cost,” Mr Powers said.
He said that Vanguard’s fixed income ETF range had been trading at discounts ranging from 1 per cent to 4 per cent over the past two weeks.
About $500m was withdrawn from BND on March 12. BND is structured as a share class in Vanguard’s $269bn Total Bond Market mutual fund, the largest of its type in the world. Investors that withdrew from other share classes of the mutual fund were able to do so at the closing NAV.
Vanguard has received calls from a number of clients who traded on that day but it has not issued any specific communication relating to the ETF via emails or on its website.
“Vanguard’s fixed income ETFs have continued to trade as expected during this volatile period, providing valuable pricing insights and liquidity for investors that need it,” Mr Powers said.