Fixed income ETFs may risk pushing market into liquidity crisis

Academic paper finds

Corporate bond ETFs may further damage fixed income liquidity during periods of market stress, despite claims of simply passively tracking the market, a new paper has found.

In a paper titled 'Steering a Ship in Illiquid Waters: Active Management of Passive Funds', the co-authors suggested that the use of authorised participants (APs) to handle inflows and outflows from ETFs left them vulnerable to worsening a liquidity crisis. This is because during a crisis, APs may "become reluctant to purchase more of the same bonds, reducing their liquidity", despite the demand of the ETF, the paper said. This would lead to worsening price dislocations, adding further stress to the corporate bond market. This is despite views that ETFs are simply passively copying...