Ok, dammit.
If EM bond ETFs eventually end up having some kind of conniption fit, you can’t say no one warned you.
I think it’s safe to say that we have been one of the loudest voices around when it comes to the extent to which HY and EM bond funds suffer from an inherent liquidity mismatch that investors are woefully uninformed about.
Indeed it was just this morning when we asked one of FinTwit’s most recognizable names if he informs his clients about this problem (we didn’t expect a response and we’re pretty sure we won’t be receiving one):
yeah but surely you inform your clients that HY ETFs and EM bond ETFs suffer from an inherent liquidity mismatch, right?
— Heisenberg Report (@heisenbergrpt) July 17, 2017
This is an issue we’ve been over and over and over. You cannot offer intraday liquidity against assets that are illiquid. It’s a logical fallacy.
If you want the full story on this as it relates to EM bond funds, you’re encouraged to check out “‘People Are Going To See There’s No Liquidity’: EM ETFs Face ‘Minsky Moment’”.
The entire charade rests on the proposition that APs are going to be willing to step in and arb NAV disconnects and that is by no means a safe assumption – especially not in the still onerous post-crisis regulatory regime where banks are not as willing to offer their balance sheet in a pinch.
Well, the latest warning on this comes from Robert Koenigsberger, chief investment officer at Greenwich, Connecticut-based Gramercy Funds Management. Consider the following from Bloomberg:
Since entering the world of emerging markets nearly three decades ago, Robert Koenigsberger has seen more than his share of changes.
One of the most consequential is the migration of allocators from hedge funds to exchange-traded and mutual funds in recent years. That’s effectively made them one-day liquidity vehicles, versus the 90-day instruments leveraged funds typically offer.
“We’re potentially sitting on one of the most illiquid market conditions in emerging markets that I’ve ever seen,” said Koenigsberger, who oversees $6 billion as chief investment officer at Greenwich, Connecticut-based Gramercy Funds Management. “This market isn’t well set up for outflows. It showed its stripes in the taper tantrum, and I think this will challenge the taper tantrum, if not 2008.”
Right. “This market isn’t well set up for outflows.”
And as a reminder, during the two weeks that followed Mario Draghi’s hawkish comments in Sintra, Portugal, and on the heels of the DM rates tantrum those comments triggered, one popular EM bond fund saw outflows totaling $1.2 billion:
Now back to Bloomberg and Koenigsberger:
Since the global financial crisis, the amount of emerging-market high-yield debt has quadrupled to about $763 billion, according to data compiled by JPMorgan Chase & Co. At the same time, dealer inventories have been scaled back to about a fifth of what they were in 2009 due to regulations, Koenigsberger said, meaning many banks no longer participate in emerging markets as intermediaries or proprietary traders.
“The question is: Is this a market or a bazaar?” Koenigsberger said. “In 2017, with the absence of banks providing liquidity, who will facilitate the flows for the one-day ETFs and mutual funds?”
We can answer that last question: nobody.
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Agree, but at least there will probably be some real bids in EM and HY ETFs during a meltdown, and almost no real bids in the individual bonds that comprise them.