Bond ETFs Face Challenges as Popularity Grows

Oct.26.09 | About: iShares iBoxx (LQD)

Fixed income has been popular among the ETF set, spurring rapid growth within this market. But is this rapid growth and popularity having consequences?

As a rule of thumb, bonds and ETFs that track them invest in stocks that can be hard to trade. As investors continue to seek returns within the fixed income market, especially with ETFs, the indexes upon which the funds are based are becoming compromised, reports Randall W. Forsyth for Barron’s.

A case in point is the rapid expansion of the iShares iBoxx $ Investment Grade Corporate Bond Fund (NYSEArca: LQD). LQD rose to $13.3 billion in assets to become the ninth-largest ETF in the United States. iShares found itself in a position in which it had to accommodate the new growth and broaden the criteria for bonds that are eligible to be included in LQD.

The vast majority of corporate and municipal bonds do not necessarily trade every day, Forsyth points out, including the issues included in the indexes upon which ETFs are based.

That said, bond ETFs are still enormously popular. They’ve gotten more than half of the new cash flowing into ETFs, reports Eleanor Laise for The Wall Street Journal. Bond ETF providers are aware of the challenges in building bond ETFs, and strive to build them so that their ETFs work optimally.

For full disclosure, Tom Lydon’s clients own shares of LQD.