Trading At The Margin
October 05, 2012
Page 2 of 3
Creation And Redemption Baskets
The managers of State Street’s SPDR US$12 billion Barclays Capital High-Yield Bond ETF (NYSE Arca: JNK), for example, use distinct creation and redemption baskets to manage inflows and outflows , each consisting of only a subset of index names.
“Our portfolio managers use the creation and redemption baskets to manage the fund’s weightings against the index,” James Maund, a New York-based member of State Street’s global capital markets team, told IndexUniverse.eu in a telephone interview. “Each day we send out a file to APs specifying a list of bonds for fund creations, typically 40-60 bonds long, and a different list of similar size for redemptions. The size of the list can vary from day to day.”
The Barclays High Yield Very Liquid index tracked by JNK has a substantially larger number of constituents, 234 in total. JNK currently holds 252 bonds, according to the SPDR website.
But, depending on market circumstances, the actual creation and redemption baskets used by State Street for JNK may be much smaller, adds Maund.
“The best way of describing the creation and redemption process is to say that the daily lists we publish act as a kind of “menu” or a starting point for negotiations between the fund manager and the fund’s APs,” Maund told IndexUniverse.eu.
“From the list of 60 bonds the portfolio manager may choose to bring in, for example, eight bonds to create the fund. We set a maximum notional value for each bond as part of the creation basket: for example, half a million dollars each in a typical creation basket size of US$4 million,” Maund explained.
Using creation baskets that are restricted in the number of securities held and which consist of round-lots of individual securities, typically half a million or a million dollars in each name, reflects trading realities in the corporate bond asset class, says Peter Tchir, founder of FT Market Advisors and a former investment bank credit trader.
“Unlike in virtually every other market, if you ask for a price in a smaller trade size in high-yield corporate bonds, the bid-offer spread increases,” Tchir told IndexUniverse.eu.
“So, for example, on a typical bond issue from Chesapeake Energy (CHK), the bid-offer spread on a US$1 million transaction might be 1 percent of par value, but for a smaller order the spread might be 3 percent or more,” Tchir explained.
Index Effect Pronounced In Corporate Bond Sector
Concerns over valuation distortions apparently caused by the growing volume of money in index-tracking funds are not new. However, the “index effect” of ETFs may be particularly pronounced in the corporate bond sector.
In a recent research publication (“the ETF Bid”) analysts at Goldman Sachs showed that the performance of the constituents of JNK’s close competitor, iShares’ US$16 billion iBoxx $ High Yield bond fund (NYSE Arca: HYG) has become increasingly detached from that of the rest of the high-yield bond sector since 2009, as inflows to the fund have soared.
And in a report published last month, researchers from BlackRock’s investment institute cited evidence from credit trading platform MarketAxess, showing that in the first quarter of this year the share of the top 2 percent of investment grade bonds by volume rose to almost a third of overall corporate bond trading, while trading in the top quintile of bonds by volume accounted for 93 percent of total corporate bond turnover.