OREANDA-NEWS. Exchange-traded funds (ETFs) are increasingly being used as favored vehicles to express changing views on the high-yield market, according to Fitch Ratings. The increase is likely reflective of more limited liquidity in the underlying high-yield bond markets, as well as the growing importance of liquid investments at a time when views on the future path of interest rates and macro fundamentals are shifting continuously.

High-yield ETF investors have historically sought liquidity during periods of volatility. On Aug. 24, 2015, against the backdrop of sharply falling global stock prices, the dollar volume of high-yield ETF trading reached a daily record 32% of high-yield bond trading. This occurred despite ETF assets representing only 4% of high-yield bonds outstanding. 

The previous high occurred the week of Oct. 17, 2014, during the Treasury market flash crash and broader market volatility.

We believe the change in high-yield trading volume could create the potential for price disconnects or forced selling in the underlying high-yield bond market. Many holdings of bond ETFs do not trade every day, compared to ETFs, which trade frequently throughout the trading day. Investors are relying more heavily on ETFs to gain exposure to the high-yield market, and quick shifts in risk appetite can lead to an increase in redemptions. Major outflows could cause fund managers to liquidate assets at unfavorable prices to meet redemption demands. This could depress prices of illiquid bonds and hurt fund performance.

The increase in high-yield ETF trading volume this year has been quite extraordinary as it occurred over a period of decreasing assets. From the end of February 2015 until the end of August, high-yield ETF assets decreased to \\$33.2 billion from \\$39.9 billion due to redemptions, as well as market value declines.

We note that investment-grade corporate bond ETFs trade much less frequently, despite having combined assets of \\$71 billion -- approximately twice as large as assets of high-yield ETFs. It appears that investment-grade ETF investors place a greater emphasis on a buy-and-hold strategy. Investment-grade ETF daily average trading volume of \\$670 million year to date is 35% less than the daily average of \\$1,029 million for high-yield bond ETFs.