The Hidden Cost of Corporate Bond ETFs

55 Pages Posted: 11 Jul 2022

See all articles by Christopher Reilly

Christopher Reilly

University of Texas at Dallas - Naveen Jindal School of Management

Date Written: June 27, 2022

Abstract

I document a hidden but substantial cost associated with the liquidity transformation that corporate bond exchange-traded funds (ETFs) provide. When creating new shares, authorized participants (APs) deliver a subset of the portfolio of bonds that underlie a corporate bond ETF. This subset contains bonds that realize low future returns, reducing ETF performance by 48 basis points per annum. This loss in performance cannot be attributed to forgone compensation for risk or illiquidity, but instead results from APs utilizing information regarding future changes in bond values to strategically deliver bonds when those bonds are expected to realize poor performance in the near future.

Keywords: ETFs, corporate bonds, liquidity transformation

JEL Classification: G12, G23

Suggested Citation

Reilly, Christopher, The Hidden Cost of Corporate Bond ETFs (June 27, 2022). Available at SSRN: https://ssrn.com/abstract=4147882 or http://dx.doi.org/10.2139/ssrn.4147882

Christopher Reilly (Contact Author)

University of Texas at Dallas - Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

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