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Tuesday, October 06, 2009

Bond ETFs Are Different Than Equity ETFs

by: Sean Hanna, Editor in Chief

Exchange-traded funds have a near-perfect reputation with the media and many investors. Yet, a spate of new products may be about to tarnish that image. One issue that is coming to the forefront are kinks now becoming apparent in bond ETFs.

Writing in the Wall Street Journal, Eleanor Laise focuses on bond ETFs' prices that are failing to track the ETFs' NAV and their underlying index as closely as investors have become accustomed to with equity ETFs.

The issue is sharpening into better focus as bond ETFs become more widely used. Today, bond ETFs hold some $86 billion of AUM, or 52 percent more than at the end of 2008. The first bond ETF launched in 2002 and there are now nearly 70 in the market, according to the paper.

One challenge faced by the ETF advisors is that the bond market has far more issues than the stock market and even bonds from the same issuer often have unique features. That means that many bonds do not trade for days at a time, making valuation more an art than a science. It also means that ETFs may not get the price they carried for the fund when the sell the securities.

Adding to the picture was the stampede into bonds -- and bond ETFs -- during the panic at the start of this year. Currently, many bond ETFs trade at a premium to their NAV. A worry is that the premium will melt away if bonds lose popularity and flows reverse back into the stock market.

Jim Ross, senior managing director at State Street, tells Laise that the above scenario is "a pretty big what-if."

"We've seen assets pretty much go one way in these funds," he adds. 

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