What’s more, ETFs typically serve as "placeholder" vehicles in lieu of strategic allocations. Investors, therefore, may be putting cash into work in the primary market during the January deluge at the expense of passive instruments.
It’s much faster to make a short, or bearish, bet on an ETF than through cash bonds, according to Andrew Brenner, the head of international fixed-income at Natalliance Securities in New York. Later when traders cover those shorts the ETFs recover, he said.
“The actual bonds could take a week to move while the ETF takes 10 minutes," he said. "But we have seen this before and the market has held, and then shorts have to grab the ETF so it outperforms."
In the short-term, the swelling gap between ETFs and the underlying market may expose some investors to basis risk, or the peril of hedging bond exposures through passive investments.
“At the very least ‘credit hedge’ products are underperforming,” Peter Tchir, the head of macro strategy at Academy Securities Inc., wrote in a note Friday. “Whether a precursor to wider weakness or setting the stage for one gap tighter back to levels closer to pre-crisis levels is the big question. With the year off to such a great start, I would err to the side of caution here. ”
This article was provided by Bloomberg News.