BlackRock: How a first-of-its-kind credit ETF became a bond market stalwart

Nov 21st, 2018 | By | Category: Fixed Income

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By Stephen Laipply, Head of US iShares Fixed Income Strategy at BlackRock.

Stephen Laipply, Head of US iShares Fixed Income Strategy at BlackRock.

Stephen Laipply, Head of US iShares Fixed Income Strategy at BlackRock.

Two decades ago few options were available to retail investors looking to assemble baskets of corporate bonds. One option was to call a broker, who in turn picked up the phone and worked orders through dealers on Wall Street.

This process was often difficult and expensive. And it could take weeks–sometimes longer–to build a diversified bond portfolio. Instead, most people paid active managers to trade and manage bonds for them in mutual funds.

Then came the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD US), the first-ever exchange traded fund tied to corporate bonds. Credit ETFs trade heavily now, but looking back to 2002, it’s hard to appreciate how novel LQD was at the time. It tracked a well-known index of investment grade bonds, providing diversification and trading efficiency.

Suddenly, individual investors could access the broad corporate bond market. A mix of 100 corporate bonds could be purchased for just pennies in bid/ask spread and 0.15% per year in fund expenses.

Adoption borne from crisis

Many institutional investors became aware of LQD during the financial crisis. As bond markets seized up, LQD continued to trade on exchange throughout the day, providing real-time markets and price discovery, especially during the memorable week roughly one decade ago that Lehman Brothers declared bankruptcy.

Source: BlackRock.

LQD’s trading volumes have climbed as investors recognized the fund’s utility. Liquidity, as measured by average daily volume, has grown steadily; liquidity spurred more liquidity, and encouraged additional adoption by institutional investors. The experience of LQD has been mirrored in other corners of the corporate debt market, where the iShares iBoxx $ High Yield Corporate Bond ETF (HYG US) has become a de facto proxy and trading instrument for the high-yield bond market. Indeed, HYG’s trading volume as a percentage of total daily volume in individual high-yield bonds rose to 19% in October, a record.

Milestones abound


iShares iBoxx $ Investment Grade Corporate Bond

– Tracks the Markit iBoxx USD Liquid Investment
Grade Index

– Provides access to over 1,000 USD-denominated,
investment grade corporate bonds in a single fund.

– Used to seek stability and pursue income.

– Listed on NYSE Arca and comes with an expense
ratio of 0.15%.

Sixteen years after the launch of LQD, the ETF has $34 billion in assets under management. It trades $725 million on average each day, up 38% from a year ago. In stressed market conditions, it has traded even more, recently as much as $2.1 billion. As volumes grow, investors can now use LQD to quickly obtain diversified exposure to more than 1,000 bonds with a single, on-exchange trade.

Investors’ predilection for LQD continues to surface in notable ways. Last year was the first time that LQD’s average daily volumes surpassed that of the most liquid individual investment grade bonds, including Verizon and JP Morgan. Adoption by insurance companies, whose portfolios rely on stable fixed income exposures, recently made LQD their most heavily owned ETF across industry portfolios. Earlier this year, LQD broke the record for the single-largest “block” trade in bond ETF history, a signal that large, institutional investors are confident about their ability to trade and manage risk with LQD in size.

What do investors get with LQD?

Beyond liquidity, LQD offers investors a highly diversified exposure to the investment grade corporate bond market across more than 1,000 bonds. LQD seeks to track a broad index, providing investors with access to bonds in all major sectors, including communications services and industrials. That makes the product potentially suitable for investors seeking broad exposure to the investment grade corporate bond market.

Source: BlackRock.

For investors with more targeted views, the LQD family suite offers choices to access the investment grade corporate bond market more narrowly. The iShares 0-5 Year Investment Grade Corporate Bond ETF (SLQD US) offers access to bonds with shorter maturities; the iShares 5-10 Year Investment Grade Corporate Bond ETF (MLQD US) offers access to bonds with medium maturities; and the iShares 10+ Year Investment Grade Corporate Bond ETF (LLQD US) offers access to bonds with longer maturities.

The iShares Interest Rate Hedged Corporate Bond ETF (LQDH US) allows investors to seek to mitigate interest rate risk and express a more direct view of bond issuers’ financial health, and the iShares Inflation Hedged Corporate Bond ETF (LQDI US) allows investors to specifically hedge against inflation risk while still owning LQD’s corporate bond exposure.

We believe that even more milestones lie ahead for LQD and bond ETFs in general as a growing chorus of investors recognize the benefits that bond ETFs provide in terms of access, efficiency and liquidity. Taken together, the iShares suite of investment grade bond ETFs are indispensable tools for investors of all types and sizes to access and manage risk in the investment grade bond market.

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)

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