Pricing and Liquidity of Fixed Income 

ETFs in the Covid-19 Crisis of 2020

EII Global Research

As of July, 2020

ICRMH0920U-1319728-1/13
How Did Fixed Income ETFs Behave During the Covid-19 Crisis?

• Fixed income ETFs generally performed as expected and provided an 

alternate source of liquidity for challenged bond markets.

• Market participants turned to fixed income ETFs for price discovery. 

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20

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70

80

90

 -

 1

 2

 3

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 5

 6

 7

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 9

Jan 2019 May 2019 Sep 2019 Jan 2020

VIX Index

Secondary Volume ($bn)

 HYG secondary volume VIX

Pricing – Fixed income ETFs 

reflected real-time value

Liquidity – Fixed income ETFs were 

efficient to trade

The Arbitrage Mechanism –

performed as expected.

iShares iBoxx $ High Yield Corporate Bond ETF (HYG) 

secondary volume vs. Cboe Volatility Index

Source: BlackRock, Bloomberg (data as of March 24, 2020)

We demonstrate this by evaluating the 

following dynamics:

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2

3

ICRMH0920U-1319728-2/13
Price Discovery:

During the height of the volatility in March 2020, bond ETFs posted large 

price discounts from Net Asset Value (NAV).

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70

75

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85

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100

105

Price ($)

GE 4.125% 2035 ABIBB 4.9% 2046

CVS 4.3% 2028 GS 6.75% 2037

VZ 4.329% 2028 LQD

A Window Into Real Time Pricing

Prices of LQD vs. Top Holdings

JanuaryFebruaryMarchApril

TLT 0.13% 0.86%

LQD 0.13% 1.39%

HYG 0.21% 1.06%

Average Absolute Stated 

Premium / Discount to NAV

Are Large Premiums and 

Discounts to NAV 

Problematic?

Source: FINRA TRACE, Bloomberg. As of 3/23/2020.

Holdings are subject to change. Holdings shown should not be deemed as a 

recommendation to buy or sell securities. For complete holdings, see www.ishares.com

Source: BlackRock, based on data from Bloomberg as of 4/30/2020.

NO.

There is information 

value.

ICRMH0920U-1319728-3/13
Price Discovery:

Market Price vs. NAV?

What Causes Discounts on Bond 

ETFs vs. NAV?

Fund NAV is calculated once 

per day using actual trades, 

dealer “runs”, and estimation 

methods.

The ETF price reflects an 

actionable trade on 

exchange.

These dynamics are 

exacerbated during periods 

of volatility.

Majority of bonds do not 

trade on a given day – NAV 

largely based on estimation. Trading activity in LQD universe, March 2020

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50

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0.4

0.8

1.2

1.6

2

2-Jan-20 2-Feb-20 2-Mar-20 2-Apr-20

Standard Deviation in 

Spread (IG)

Standard Deviation in 

Price (HY)

HY (Price Domain) IG (Spread Domain)

Deviation of Dealer Quotes to Actual Trade Price

Source: FINRA TRACE, BlackRock from 3/2/2020 – 3/20/2020. Includes only end 

investor buys and sells – not dealer-to-dealer trades. 

Source: FINRA TRACE, Dealer quotations.

ICRMH0920U-1319728-4/13
Price Discovery: 

Intraday Intrinsic Value?

As of 6/26/2020. Source: BlackRock, Bloomberg and Refinitiv.

• Bottoms-up, bond-by-bond valuation, 

calculated throughout the day.

• 12-factor intraday bond valuation 

model developed by BlackRock in 2015.

What Is Intraday Intrinsic Value?

• On March 24th: HYG traded at 2.4% 

closing premium to NAV, but only a 

0.4% average intraday premium to 

Intrinsic Value.

Intrinsic Value Offers an Intraday 

Estimate of ETF Premium / 

Discount

(900)

(600)

(300)

0

300

600

900

1,200

67

70

73

76

79

82

85

88

3/23/33/43/53/63/9

3/103/113/123/133/163/173/183/193/203/233/243/253/263/273/303/31

Primary Market Activity (million USD)

Price (USD)

iShares HYG ETF

flow at T (right axis) iShares IV ETF Price NAV at T-1

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-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

3/23/33/43/53/63/9

3/103/113/123/133/163/173/183/193/203/233/243/253/263/273/303/31

b/a Spread (bps)

P/D

iShares HYG ETF

P/D to NAV at T-1 P/D to iShares IV ETF b/a spread (right axis)

ICRMH0920U-1319728-5/13
Price Discovery: 

The presence of lag effects in Net Asset Values

Daily NAV-Based Returns 

Exhibit Positive 

Correlation to the 

Previous Day’s NAV 

Return.

Daily ETF Total Returns 

Have Tended To Be 

Uncorrelated To Past 

Returns.

Source: BlackRock, based on daily NAV returns from Bloomberg

Autocorrelation Function for LQD 1/2/20-4/30/20

Autocorrelation Function for HYG 1/2/20-4/30/20

ICRMH0920U-1319728-6/13
Price Discovery: 

Large Premiums/Discounts Do Not Persist

Source: BlackRock, Bloomberg. 3/31/20

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

ETF Price 

– NAV 

FLOT LQD MUB HYG TLT Net Asset Value

Bond ETF Prices and NAV Converge As Markets Normalize, March 

2020

ETF Price 

Reflects RealTime, Actionable 

Value for 

Portfolio.

Convergence 

occurs once 

volatility / lag 

effects dissipate

Price Innovation 

in NAV tends to 

lag.

ICRMH0920U-1319728-7/13
Liquidity: 

Bond ETF volumes tend to accelerate during Volatility

While liquidity became 

challenged in the 

underlying bond markets, 

bond ETFs traded at record 

volumes on exchange.

Source: BlackRock, based on data from Bloomberg as of 4/30/2020.

Average Daily Exchange Volumes ($bn)

Average Primary to Secondary Volume %

Average daily volume 

during Q1 2020 was more 

than 2x that of 2019.

Primary to secondary ratio 

rose modestly in stress 

period

 $-

 $0.5

 $1.0

 $1.5

 $2.0

 $2.5

 $3.0

 $3.5

FLOT LQD HYG TLT MUB

$ billions

2019 1Q-2020

JanuaryFebruaryMarchApril

TLT 9.83% 10.28%

LQD 12.99% 14.66%

HYG 7.99% 9.58%

ICRMH0920U-1319728-8/13
Liquidity: 

Bid-ask spreads – “liquidity mismatch”?

Source: BlackRock, Bloomberg. 3/31/20

Average bid/ask spread (price bps), March 2020

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160

Broad

Market

U.S.

treasuries

Investment

grade

corporates

High yield

corporates

Emerging

market

debt

ETF bid/offer Underlying bid/offer

Bid/ask spreads for fixed income 

ETFs are much lower than that of 

individual bonds.

No. Bond ETFs should trade at 

tighter spreads (portfolio effects, 

transparency/efficiency of 

exchange).

Bond ETFs represent a diversified 

portfolio of bonds: less 

idiosyncratic risk than individual 

bonds.

Is this a concern - “Liquidity 

mismatch”? 

ICRMH0920U-1319728-9/13
Is the Bond ETF Arbitrage Mechanism Efficient?

When the ETF share price trades at a true (actionable) premium or discount 

to the value of the securities held by the ETF, there is an ECONOMIC 

INCENTIVE for Authorized Participants (APs) to create or redeem shares to 

capture value (and thereby close the differential). 

Bond ETF is 

trading at a true 

discount to est. 

portfolio value

(ETF $85, bond 

portfolio $90)

AP buys ETF 

shares on 

exchange for 

$85

1

AP redeems 

ETF shares, 

receives 

underlying 

bonds, closes 

out trades.

2

AP sells 

underlying 

bonds in the 

market for 

$90.

3

AP profits 

$5.

4

Simple Example of bond ETF arbitrage: 

APs are generally not incentivized to engage in creation/redemption unless 

the arbitrage is (i) actionable and (ii) profitable (or at least neutral)

For illustrative purposes only. Although market makers will generally take advantage of differences between the NAV and the trading price of 

iShares ETF shares through arbitrage opportunities, there is no guarantee that they will do so.

ICRMH0920U-1319728-10/13
Can there be “Wrong Way” Arbitrage?

TLT LQD HYG

Estimate p-Value Estimate p-Value Estimate p-Value

Intercept -0.02 0.03 0.00 0.06 -0.01 0.06

Premium.IV 46.08 0.01 1.76 0.04 0.84 0.56

Crisis 0.03 0.01 0.01 0.00 0.02 0.01

Premium.IV*Crisis -43.69 0.02 -1.39 0.10 -0.33 0.82

Adj. R-Squared 0.455 0.336 0.158

Recent academic research purports the existence of “wrong way” arbitrage in bond 

ETFs driven by dealer balance sheet dynamics:

• Motivation to manage bond inventory and balance sheet costs outweighs the loss on 

the “wrong way” arbitrage.

• Two primary issues with the theory: 

– Conflation of broker-dealer / AP and market-maker roles

– Use of closing premiums/discounts to NAV which are end of day valuations subject to lag effects

We regress bond ETF creation/redemption flows on the average intraday 

premium/discount to intrinsic value and add an interaction term for the crisis period. In no 

case are the coefficients negative. Accordingly, we find no evidence of wrong way 

arbitrage even in times of market stress.

Regression Estimates of Daily Primary Flows Scaled by AUM 

Source: BlackRock, based on data from Bloomberg as of 4/30/2020. Estimates that are significant at the 5% confidence level are in bold.

ICRMH0920U-1319728-11/13
Conclusions

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3

Bond ETFs serve as vehicles for efficient price discovery

• Amid increased trading during the Covid-19 crisis, fixed income ETFs were indicators of 

real-time, actionable prices.

• Bond ETF prices showed large deviations from NAV. However, we believe these deviations 

were a function of price discovery coupled with NAV latency effects in a challenged 

liquidity environment.

• Bond ETF prices represented actionable values on exchange based on elevated volumes.

• We find that Intraday Intrinsic Value provides real-time information value relative to endof-day estimates.

Bond ETFs were more efficient to trade than the underlying bonds.

• While fixed income ETF trading costs are generally cheaper than those of underlying 

bonds, this difference was magnified during the Covid-19 crisis.

• Bond ETFs traded in record volume while the underlying market experienced liquidity 

challenges.

We find no evidence supporting claims of “wrong way” arbitrage.

• We find no empirical evidence for the claim that Authorized Participants are motivated to 

engage in money losing bond ETF primary transactions due to balance sheet dynamics.

ICRMH0920U-1319728-12/13
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ICRMH0920U-1319728-13/13