Fed Starts Buying Individual Corporate Bonds: An ETF Update

The US Federal Reserve (Fed) recently announced it would purchase individual corporate credit bonds. David Mann, our Head of Capital Markets, Global ETFs, makes a case for using smaller ETFs to accomplish that goal.

Last week, the Federal Reserve Bank of New York announced it would start purchasing individual corporate credit bonds on June 16 within the Secondary Market Corporate Credit Facility (SMCCF). This is the same Facility in which it has already been purchasing ETFs since May 12. As my loyal readers can attest, the Fed and ETFs have certainly been hot topics in this forum.

Given that this is an ETF blog, I am not going to dive too far into the weeds of how the Fed is constructing its broad portfolio of US corporate bonds within the Facility. However, I did want to repeat a point I made in our very first commentary about the Fed buying ETFs.

The Facility should want low ratios (ratio of exchange volume to primary market volume) as those ETF trades would lead to actual buying of the underlying bonds. Our recommendation would be to focus on low-ratio ETFs (for example, under 3:1 over the past 12 months) as we want that primary market activity. Purchasing high-ratio ETFs may not even lead to any buying of the underlying bonds, depending on what is happening in the market that day.

The Fed has already bought ETFs and has now moved onto the next phase of owning individual bonds. What if the Fed not only has its cake, but gets to eat it too? By investing in smaller fixed income corporate bond ETFs with lower average volumes, almost every dollar invested in those ETFs would be a dollar invested in the underlying bond markets.

Put another way, the motivation for using ETFs within the Facility would now be slightly different. The purchases we have seen thus far into the largest ETFs allowed broad exposure to the corporate bond market, but they did not necessarily lead to individual bond buying because of all that on-exchange volume. Now, these smaller ETFs could be used as an explicit conduit for buying individual bonds which is consistent with the aim of the SMCCF.