The Fed and Fixed Income ETFs: The ETF Issuer Spread Widens Further

by David Mann of Franklin Templeton Investments, 4/17/20

As the ravages of the coronavirus reverberated through the global economy in March and into April, the Federal Reserve announced a number of measures to help provide relief to financial markets—one being the purchase of exchange-traded funds (ETFs). In the final post of a three-part discussion on the topic, our David Mann opines on the Fed’s inclusion of high-yield ETFs within these purchases.

This post was meant to be my last on the topic of the Federal Reserve (Fed) buying ETFs as part of a range of measures to support the markets. Very simply, I wanted to summarize my main issue with the Fed’s announcement—only to find out that the Secondary Market Corporate Credit Facility now includes an update! Now, ETFs whose investment objective is exposure to US high-yield bonds will also be included along with investment-grade bonds.

As I wrote in my last blog post, the largest ETFs that provide exposure to investment-grade bonds saw an immediate influx of assets. Updating those stats through April 8, those funds have received inflows of over $8.5 billion, which equates to an annual revenue run rate—an expectation of annual revenue extrapolated over a year—of almost $13 million.1 And given the Fed’s most recent announcement, it will not surprise me if we see similar numbers for high-yield ETFs as well.

For those who have been reading this blog since I first started putting pen to paper, it should be obvious by now that getting a new fund to scale is quite the challenge. At the top of the list as to why is related to the new fund’s counting stats (size, volume and spread), which will almost certainly be worse than the incumbent to which it is compared. However, the good news—and one of the main reasons Franklin Templeton was the fastest-growing ETF issuer in the United States in 20192—is that investors are now taking the time to better understand ETF trading and the misconceptions associated with those counting stats. To recap:

The bid/ask spread does not tell the whole story about an ETF’s round trip trading cost.

Volume is not an accurate gauge of liquidity (just like terrific new restaurants may go unnoticed for a while).

Assets under management are also not an accurate gauge of liquidity.

A Level Playing Field?

Back to the Fed announcement. We applaud the Fed including ETFs in the Secondary Market Corporate Credit Facility, given how fixed income ETFs have become the investment vehicle of choice for so many. Unfortunately, by not specifying the exact ETFs to be included, the public had no choice but to assume that the typical ETF counting stats would be used.

The end result: $13 million of additional annual revenue to the largest ETF issuers. Some nuance would have been nice to see here given all the steps the Securities and Exchange Commission took to create a level playing field within the ETF space, including the explicit validation that active and passive ETFs are operationally no different.

It’s too bad! We have an active ETF with over $500 million in assets (as of April 14, 2020) that holds investment-grade bonds and would love to have been included.