Existing indices for corporate bond ETFs have always been designed on proxies used for liquidity, such as issue size, maturity buckets, rating buckets or other characteristics. They tend to be large with a large number of CUSIPs (the unique identification number for registered bonds).
“Importantly, the index’s construction guidelines limit the total number of CUSIPS to 400, while providing risk characteristics that align with other broad-based US IG corporate bond indices. “, said Ahmuty.
Partners in Innovation
The launch of LQIG is part of State Street Global Advisors’ efforts to partner with bond market leaders who bring unique insights to the market. “Transparency is growing in the bond market, especially in the US IG market where MarketAxess has long held a leadership position in electronic bond trading,” he said. “MarketAxess has a unique view of bond market liquidity, having created the largest institutional market for trading bonds.”
The MarketAxess US Investment Grade 400 Corporate Bond Index applies two proprietary liquidity filters to the eligible universe of corporate bonds.
This first screen, Composite+ (CP+), is an algorithmic pricing engine that analyzes trading and liquidity data inputs and generates an indication of a bond’s bid and ask price. Refreshing every 15-60 seconds, it covers around 13,500 US corporate bonds and around 90-95% of trading activity in its market. If there is insufficient liquidity to generate a CP+ bid or ask price for a bond, the issue is not eligible for inclusion in the index.
“With quoted bilateral market prices, based on MarketAxess’ CP+ pricing engine, real-time index prices for all its components,” Ahmuty explained. “And in the field of credit, this did not exist until now. Seeking to follow the index, LQIG is designed to bring true price transparency to the US IG credit market in an ETF package that makes trading easier.
The second liquidity screen is the Relative Liquidity Score (RLS), a measure of the current liquidity of individual bonds relative to similar issues that analyzes industry and proprietary trading data. Bonds are assigned a rating between 1 and 10, with 10 representing the highest level of liquidity. As the index seeks exposure to more liquid IG bonds, issues must have an RLS of 7 or higher to be included.
Avoid illiquid tail risk
LQIG’s underlying index methodology reduces the potential for illiquid tails present in many broader indices.
“Most bonds in the market do not trade every day, and their volumes have tended to drop dramatically within months of issuance,” Ahmuty said.
According to data from SIFMA, the $10 trillion corporate bond market is seeing 0.4% turnover every day, while electronic multi-dealer platform MarketAxess reports nearly 22% of the total TRACE volume in the US IG corporate universe comes from just over 300 CUSIPs. “Also, some indices may have smaller issues or bonds that do not trade frequently, so prices may not always reflect true market risk/sentiment,” Ahmuty noted.
“LQIG’s underlying index capping the number of bonds at 400, along with the bonds in the index being relatively highly tradable with bilateral CP+ markets, may increase the likelihood of full replication of creation baskets and takeover of LQIG,” Ahmuty explained. “It’s similar to what we see in equity ETFs in terms of the ease of the creation/redemption process for brokers. So this approach is designed to take a stock-like infrastructure and apply it to the world of bond ETFs.
Focus on trade execution
When investors consider their liquidity needs, Ahmuty suggests they consider the total cost of ownership of an investment. That is, in addition to fees, it is important to consider the cost of execution to enter and exit positions.
While LQIG’s gross expense ratio is 0.09%, its net expense ratio is 0.07% is 50% lower than its peer class average net expense ratio of 0.14%. “Investors can consider execution strategies, such as avoiding trades when the market opens or closes and the importance of evaluating premiums and discounts on ETFs,” he said. .
In addition to thinking about the bid-ask spread, Ahmuty said it’s important to assess how a particular ETF is trading relative to its net asset value. “This is a key consideration that needs to be fully understood – and inferring the fair value of a fixed income ETF isn’t always easy,” he explained. “We believe LQIG’s potential for meaningful price transparency is helpful here.”
Interest in credit ETFs has exploded as they have become a price discovery tool. “Although the underlying bonds do not update their prices very frequently, ETFs provided additional price transparency in the market,” Ahmuty said. “SPDR ETFs provide daily files of their holdings, allowing investors to know exactly what they own on a daily basis. It’s a really important concept, knowing what you own, especially in times of tight markets.
Meanwhile, advances in fixed income market data continue to make it easier for investors to assess the different facets of liquidity. “Liquidity is an important element and although it’s been talked about a lot in trading, we believe it hasn’t really been seen as a key element in index construction so far,” Ahmuty said. . “The focus has always been on the liquidity of an ETF in the secondary market. However, we now have an ETF that relies on an index focused on the liquidity of the underlying bonds. This approach has the potential to more closely align the ETF’s liquidity with that of the index it seeks to track.
Invest in LQIG
LQIG’s exposure to an index that emphasizes liquidity and enforces sector and issue constraints can support a wide range of uses within institutional portfolios.
“First and foremost, LQIG is built on a liquidity-focused index. It is designed to be a very marketable product,” Ahmuty said. “Overall, the potential for higher interest rates and continued market volatility resulting from prevailing macroeconomic and geopolitical forces may continue to accelerate investors’ need for more liquidity and transparency.” He concluded, “We consider this to be the perfect time to launch LQIG as it provides traders, money managers and pension funds with an additional tool to take advantage of current market volatility.” ■