Why bond ETFs traded at discounts to NAV last month

In March, many bond ETFs traded at double-digit percentage discounts to their net asset values (NAVs). In a report on Wednesday, National Bank of Canada Financial Markets explained why and offered trading tips for ETF investors.

As the market sold off last month in response to the pandemic, the price decline in many investment-grade and aggregate bond ETFs in Canada and the U.S. concerned investors, as those funds are supposed to act as a cushion during volatility.

Prices dropped in these funds in response to the uncertain market’s widening spreads and the illiquidity of underlying assets as trading volumes increased.

“Stocks, corporate bonds and even Treasuries either plummeted in price or froze in liquidity,” the report said. “Many corporate bonds and some government Treasuries went no bid, or they experienced sudden spikes in bid/ask spread.”

Yet, NAV numbers for ETFs don’t capture true liquidity cost because they’re calculated by methods that lead to stale numbers, the report said: “ETF and mutual fund NAVs come from third-party bond pricing agencies using non-actionable quote data.”

Further, it said closing price often occurs on low volumes compared to the full day of trading.

For a true idea of what ETF investors paid for intraday liquidity in March, National Bank calculated the funds’ volume-weighted average price (VWAP) discount in dollars — the actual dollars that investors paid on average to access bond liquidity via ETFs.

VWAP discounts to NAV showed that the price of intraday liquidity was much lower than reflected in fund prices.

To help deal with the challenge of apparent discounts to NAV, the report provided tips for “proper trading hygiene,” including using limit orders, avoiding trading during the first or last quarter-hour of the trading session and remembering that these so-called discounts are generally temporary.

“They do not impact buy-and-hold investors,” the report said.

For full details, read the report from National Bank of Canada Financial Markets.

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.