When it comes to capital markets, the Federal Reserve has a big footprint. And now the Fed’s footprint is all over the U.S. exchange-traded fund bond market.
As part of the CARES Act, the Fed began buying ETFs linked to U.S. bonds on May 12 and has already amassed a $1.3 billion stake, according to its latest May report. Rather than targeting specific bonds from single issuers, the Fed’s mandate is to own corporate bonds via ETFs that offer broadly diversified exposure to the U.S. corporate bond market.
Thus far, the Federal Reserve has scooped up bond ETFs from five managers: BlackRock; DWS; State Street Global Advisors; VanEck and Vanguard. BlackRock’s iShares unit has been the biggest beneficiary with the seven iShares ETFs owned by the Fed currently accounting for nearly half of the $1.3 billion allocation.
After collapsing into bear-market territory in mid-March, bond ETFs have rallied sharply and in some cases have recorded year-to-date gains.
Popular bond ETFs like the Vanguard Total Bond Market ETF (BND) and the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) have gained between 4% to 6% year to date. BND and LQD own highly rated investment-grade debt, which is considered lower risk from a credit standpoint.
Unlike its peers with higher credit quality bonds, the SPDR Bloomberg Barclays High Yield Bond ETF (JNK) has declined 3.5% since the start of the year. Regardless, the Fed has been snapping up lower-rated corporate bonds via funds like JNK, too.
Among the Fed’s bond ETF purchases, 83% have flowed into investment-grade corporate bond funds while the remaining 17% have gone into high-yield bond ETFs. The Fed’s top three bond ETF holdings from the May report are the previously mentioned LQD ($326.2 million position), the Vanguard Intermediate-Term Corporate Bond ETF (VCIT), with $228.1 million, and the Vanguard Short-Term Corporate Bond ETF (VCSH), with $226.2 million.
The Fed’s entry into the U.S. bond market via ETFs is a historic event. Could this set the table for the Fed to buy other types of assets via ETFs, including beaten-up shares in the real estate investment trust sector? Don’t count it out, even though the Bank of Japan has owned equity ETFs since 2012 and now dominates the Japanese ETF market, owning more than 75% of the $382 billion in total assets.
The Fed’s initial round of bond ETF purchases is capped at $25 billion and will run through September 2020, according to the New York Federal Reserve.
The U.S. bond market is the largest and most important credit market in the world. It represents 39.4% of the $103 trillion securities outstanding across the globe, or $41 trillion through June 2, according to Securities Industry and Financial Markets Association. By comparison, the next largest credit market, the EU, is roughly half the size of the U.S. market.
Ron DeLegge is founder and chief portfolio strategist at ETFguide, and is the author of “Habits Of The Investing Greats.”