Tuesday’s Wall St. Journal article on bond ETF pricing grabbed immediate front-page attention on Seeking Alpha, a righteous sign of these investments’ popularity and the site’s always-on radar systems.
Briefly, the WSJ article points out that popular corporate bond ETFs, including both the iShares short-term investment grade ETF (CSJ) and its long-term ETF (LQD), and the SPDR high-yield ETF (JNK) can trade at significant premiums to their underlying assets, as well as fall short of the returns of their respective indexes.
Both the WSJ article and an SA contributor pinpoint some clear insights on these issues. Among them, bonds don’t trade on transparent exchanges and some of the bonds in the underlying indexes don’t trade much at all.
And that can lead to pricing discrepancies as well as real differences between the ETFs’ holdings and the indexes’ components. In explaining the recent underperformance of JNK, for example, a spokesman said the ETF was simply unable to buy some of the lower-quality bonds that helped goose the index higher.
That said, let me slip another duck onto the pond, perhaps a lighter one, but at least worth considering.
The price premiums on these ETFs are at least partly a ‘convenience premium’ investors are willing to pay because some of the demand for corporate bonds simply cannot be met through buying the underlying assets or indexes (which the ETFs cannot even buy, as the JNK spokesman pointed out).
Specifically, for individual investors and I imagine some small or midsize money-managers as well, buying the indexes themselves is not a real alternative anyway, and wading into the pool far enough to assemble a decent portfolio of individual corporate bonds gets into murky water fast.
Conversely, the instant diversification, stock-like commissions and low expense ratios (granted, not the only costs associated with the buy) of these ETFs provide enough convenience-value that investors figure the package is worth the price. In fairness, it might be noted that some open-ended mutual funds perhaps could do the job as well.
References and Links:
Wall Street Journal,“Bond ETFs Are Popular, But Pricing Is A Problem,” October 6, 2009.
Felix Salmon on Seeking Alpha, “The Problem with Bond ETFs,” October 6, 2009.
Disclosure: Long CSJ
