Market volatility due to Covid-19 has created a buying opportunity in the corporate bond space, according to ETF experts from BMO and Horizons.
Bond ETFs — and corporate bond ETFs in particular — have been trading at a substantial discount to their net asset value (NAV) during the market sell-off, said Alfred Lee, portfolio manager and investment strategist with BMO Global Asset Management.
“If you look at the NAV of an ETF in a normalized market, that’s a pretty good indication of the value of the underlying portfolio,” Lee said in an interview.
But during the sell-off, bond dealers have been reluctant to mark their books down and many bonds haven’t traded in several days, Lee said. This inflates an ETF’s NAV, so bonds are currently trading at a discount to their net asset value.
The ETFs’ price will eventually get back to a point where the NAV is accurate, which creates a buying opportunity in the meantime.
The current market turmoil has resulted in corporate bond spreads that are “very, very wide” and illiquidity in the marketplace, said Steve Hawkins, CEO of Horizons ETFs Management (Canada) Inc.
“We’ve heard that several bond desks are essentially ghost towns, because the bond traders are not there,” Hawkins said. “There’s just too much risk, in their view, of stepping into this market with all this uncertainty.”
This, Hawkins said, has created an environment where it’s easy for buyers to take advantage of eager sellers.
“Right now, the people who are buying [corporate bonds] in this marketplace are essentially pawn brokers,” Hawkins said. “They’re taking advantage of the unsuspecting clients and investors who feel like they have to get out of this marketplace, rather than hold steady.”
This means there are great buying opportunities, Hawkins said, both directly and through ETFs, which offer the advantage of greater liquidity.
“[An ETF] does give investors the ability to get out of the bond market should they need to, whereas in the underlying bond market, it’s a different story — they can’t get out,” Lee said.
As long as the current market volatility persists, bond markets will “continue to be dysfunctional,” Hawkins said. But the dysfunction won’t last forever.
“Every fixed-income ETF is struggling [right now] with respect to discounts to NAV, from a trading perspective,” Hawkins said. “We believe that this is going to pass. As soon as there is some reasonableness to this marketplace, we think that these discounts are going to close very, very quickly.”