Alan Brochstein

Largest Bond ETF Now Trading At a Massive Discount

That makes sense, Chris B - they are pretty close to the same thing. I don't believe that the discount is so great on AGG any longer, though it is somewhat below the NAV.

Largest Bond ETF Now Trading At a Massive Discount

I think your point is well taken, as some of the comments have adressed the issue. I do believe that a certain amount of NAV question discount should exist after considering the point. If the Corporate bonds are off by 10%, that would imply about a 2% total discrepancy. I don't know exactly how wide the spreads are on the "safer" securities that represent the remaining 80%. Still, though, consider this. If you own the Vanguard Total Bond Market Fund ETF (BND), I believe it is part of a larger underlying pool of assets that is offered as a mutual fund. If this persists, it would be almost riskless to sell the mutual fund (at the 4pm price) and buy the ETF at the 4pm close. My point isn't really that one should arbitrage this but rather suggest that this is a relatively cheap way to buy exposure to the broad bond market in a highly liquid and low cost manner. Some others have suggested that they would rather go after traditional closed-end funds at off-the-charts discounts of 30% or so, and I can't argue with that strategy in the long-run (though it is riskier and more expensive over time if the gap doesn't close quickly). Your acronym suggests that you might be able to tell me how wide the bid/offer is on Agency mortgages in the TBA market. Care to share?

Largest Bond ETF Now Trading At a Massive Discount

Robert_A,

First, some of the closed-end funds surely could prove to be fantastic investments. Remember, though, that their managers get paid on the NAV, not the stock price. They have a disincentive to reduce the size of the ETF - it costs them money (i.e tendering for shares on the open market). I don't follow that market so closely, but I recall a lot of shareholder suits in the past.

As far as buying the super-duper cheap closed-end funds and shorting the merely heavily discounted ETF seems foolish to me. Recall that the fees are much higher (over 5X, on an annual basis) for what you would be buying. Additionally, you are subject to active manager performance. Perhaps most importantly, you are assuming a great deal of risk known as "basis risk": You are short Treasuries, mortgages and investment-grade corporate bonds to go long either municipal bonds or junk bonds. I am not trying to make a "value" call on your proposed trade but rather point out some reasons that it isn't the lay-up that you perceive. I have friends and clients who have been buying the 30% discounted funds. Of course, they were buying them when they were at 15% too.

Largest Bond ETF Now Trading At a Massive Discount

hardball 22, first, I would expect an exemption. Second, the 14 funds could be sold to someone else if necessary. Third, how much higher do you think the expenses would be? The fund has $9 billion in assets. It seems like the cost if even $1mm is rather trivial (it's late here in Texas, but that is about 1 bps). Why then aren't the other 13 funds trading at a big discount? This fund is a tuna fish and the other 13 are minnows. If this argument were true, the other funds would be reflecting the poor future economics even more. It's simply not an issue.

I think that I have identified in the original article almost all of the underlying factors. I appreciate those of you who shared your opinions, as I learned that I omitted one factor: Bid-offer spreads have widened significantly, which contributes to some uncertainty regarding the true value of the NAV. Remember, though, that the illiquid bonds are primarily the pure corporate bonds, and they represent about 20% of the portfolio. Let's say that they are off by 10% - this would account for just 2% of the discount.

Largest Bond ETF Now Trading At a Massive Discount

CMA CMA, I don't believe I ignored it at all. I believe that due to market conditions, this situation may persist somewhat longer than one might normally assume. I am unaware of a large passive ETF with open redemption/creation trading anywhere near this kind of discount. As I acknowledged in the article, there are lots of really cheap closed-end funds, but there isn't a mechanism to arbitrage the differences. An investor is subject to high fees (on the NAV, by the way) as well as potential mismangement by the active manager. I am not trying to make a judgment - they are probably both ultimately great buys. AGG is just a safer one.

Largest Bond ETF Now Trading At a Massive Discount

Halfempty, it wasn't just the "last quoted price". There was selling pressure all day. As I mentioned in the article, 1.5mm shares traded ($140 mm) compared to the normal 600k.

Alex_G, you do raise a good point, but the discount seems then it would be greater on a pure corporate bond ETF than one that includes a lot more MBS and Treasury securities. CFT, which is a rather small ETF, closed at 77 compared to an NAV of 86 (slightly wider). That one is 100% corporate bonds compared to AGG being just 20% or so. I appreciate your observation, though - that NAV could be somewhat suspect.

Largest Bond ETF Now Trading At a Massive Discount

Brian, I have spoken only to my institutional clients and directly to an iShares representative. He informed me that they had received a ton of calls. If I understand the dynamics correctly, this won't persist for long. As I wrote above, though, lots of fires to put out, this one isn't the most pressing. Theoretically, though, for those who don't understand my point, someone with $8.5 billion dollars could buy the whole fund and turn around and exchange it for $9.4 billion (i.e make almost $1 billion, less the 2% fee).

Largest Bond ETF Now Trading At a Massive Discount

BxCapricorn, my point isn't that it could drop in value. Did you read the article? The market price is substantially below the intrinsic value of the underlying assets despite the fact that there is a mechanism to keep it roughly in line via the Redemption process (page 4 of the prospectus). In a former life, I was a professional bond-trader - I understand that the underlying assets can change in value.