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Rick Ferri on Corporate Bond ETFs vs. Funds

 
 
David S Meyers CFP
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      11-17-2011, 12:04 AM

I found the following article particularly interesting, and
given "dumbstruck"'s posting this morning about market
versus limit orders, it seemed related enough that others
might also find it interesting. Ferri's work is always
a pleasure to read.

http://www.rickferri.com/blog/strate...ate-bond-etfs/

Why We don't Buy Corporate Bond ETFs

Corporate bond ETFs don't work for our clients. Large price discounts
and premiums to net asset value (NAV) tend to occur when we are
trading. These deviations from NAV can add unnecessary trading cost to
portfolios. Accordingly, we're believers in traditional corporate bond
mutual funds that trade at NAV at the end of the day.

The size of the ETF NAV/MktPx discounts that Ferri demonstrates
were actually surprising to me. I've been generally pretty happy
with the performance of LQD (the iShares iBoxx $ Investment Grade
Corporate Bond ETF) - transparency of holdings, a good index, very
low costs, plenty of liquidity in the ETF. As liquid as the holdings
in LQD are, the discount it displayed was surprising, though not
surprisingly, a lot smaller than the corresponding spread for
the high-yield ETF, HYG.

I'd be very interested to see how Vanguard's unique ETF-as-a-share-class
affects this. Vanguard's got both open-end shares as well as ETF
shares of their Intermediate-Term Corporate Bond Index - VCIT and
the institutional share open-ended class shares VICBX (theoretically
the min. invst is $5million, but there may be ways around that).

Morningstar suggests that VCIT, LQD, CFT and CORP are all direct
competitors. LQD is by very far the largest and most liquid, at
over $16billion in assets. VCIT (and the corresponding institutional
shares all together) has about $0.9billion, CFT has about a billion
and CORP, by far the smallest of the group, is only about $75million.

Anyway, Ferri's article is well worth the read.

There may be some closed-end funds worth looking at in this area,
too, since CEFs have the advantage of not having to create or
redeem shares, they don't get hit by liquidity/trading issues
the same way open-ended or ETFs might. On the flip side, though,
CEFs often have (a) high management fees; (b) leverage; and (c)
discounts/premiums to NAV are sometimes erratic, though (c) may
also present some opportunities when discounts are wider than
usual for a given CEF. I generally stay away from CEFs due
to (a) and (b) (and general aversion to actively managed funds
in the first place).

--David


--
David S. Meyers, CFP(R)
http://www.MeyersMoney.com
disclaimer: for educational purposes only. This is not financial advice.

 
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terrable
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      11-17-2011, 03:29 PM

"David S Meyers CFP" <(E-Mail Removed)> wrote in message
news:(E-Mail Removed)...
>
> I found the following article particularly interesting, and
> given "dumbstruck"'s posting this morning about market
> versus limit orders, it seemed related enough that others
> might also find it interesting. Ferri's work is always
> a pleasure to read.
>
> http://www.rickferri.com/blog/strate...ate-bond-etfs/
>
> Why We don't Buy Corporate Bond ETFs
>
> Corporate bond ETFs don't work for our clients. Large price discounts
> and premiums to net asset value (NAV) tend to occur when we are
> trading. These deviations from NAV can add unnecessary trading cost to
> portfolios. Accordingly, we're believers in traditional corporate bond
> mutual funds that trade at NAV at the end of the day.
>


Ferri's problem is that he wants to do things backwards: buy bond ETFs when
they are at a premium to NAV and sell bond ETFs when they are at a discount
to NAV.

Normal people can do it the normal way: buy bond ETFs when they are at a
discount to NAV and sell bond ETFs when they are at a premium to NAV.

Make the bond ETFs premium/discount to NAV work for you and the problem is
solved.

 
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Tad Borek
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      11-17-2011, 07:10 PM
On 11/16/2011 4:04 PM, David S Meyers CFP wrote:
> The size of the ETF NAV/MktPx discounts that Ferri demonstrates
> were actually surprising to me.
>
> There may be some closed-end funds worth looking at in this area,
> too, since CEFs have the advantage of not having to create or
> redeem shares, they don't get hit by liquidity/trading issues
> the same way open-ended or ETFs might.



There are a few bond ETFs that I keep an eye on where the
discount/premium spread runs over 3% in either direction. Not every
quarter, but often enough that it's something to check on. And in
general, trading spreads are pretty wide.

Note though that depending on the bond ETF you're talking about, there
can also be uncertainty about NAV itself. Some bonds just don't trade
that often, and to the extent the ETF holds those it introduces some
uncertainty in the NAV of the ETF. So it's rational for the spreads to
be wide and there to be persistent discounts/premiums.

CEFs have a much bigger issue in this regard, they have much higher
liquidity/trading issues than ETFs which at least have an arbitrage
mechanism to keep their pricing somewhat in line. With CEFs you can add
in a layer of premium/discount variability that is larger than the two-
or three-year yield of the underlying bonds. Heck, 6-7+ years in one
case. Who are the investors currently buying certain Gross-ly overpriced
bond CEFs? Even assuming some NAV uncertainty, it makes no sense.

-Tad

 
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