However, the Fed's pledge March 23 to buy investment-grade credit and certain ETFs helped halt the slide in mutual fund net-asset values and sparked a rally in higher-rated debt. That's largely due to the fact that fund managers now have a willing buyer on the other side of the trade, according to Bloomberg Intelligence."Mutual funds dodged a big bullet by not having to unload bonds into a market with no buyers," said Eric Balchunas, senior ETF analyst. "The Fed has now brought liquidity, and so they will get to avoid the 'hell' we saw ETFs in for the past month."
The U.S. central bank said March 23 that it would create a Secondary Market Corporate Credit Facility, one of several new measures aimed at cushioning the economic blow from the coronavirus. The terms of the facility allow for the purchase of up to 10% of an issuer's outstanding bonds and up to 20% of the assets of any ETF "whose investment objective is to provide broad exposure to the market for U.S. investment-grade corporate bonds," a primer accompanying the Fed action said.
That Fed's move quickly stemmed the bleeding in high-grade bond markets, where investors were shedding even their highest-quality holdings in an effort to raise cash. The carnage quickly appeared in ETFs, which trade on exchanges and behave like stocks, as the funds sold off much more quickly than the underlying bonds.
The pain had just started to spread to mutual funds, which were initially able to satisfy redemptions by burning through cash and their more liquid securities, according to Kingsview Wealth Management's Paul Nolte. The net-asset values began to drop as the fund managers were forced to try and liquidate harder-to-unload holdings into a market with few buyers — but the Fed announcement broke the cycle, he said.
"They've stepped in, and we're now finally starting to see a little bit more of a normal bidding process in the market," said Mr. Nolte, a portfolio manager at Kingsview Wealth Management. "We're probably a week away from a normally functioning market. It's going to take some of these funds a while to work their way back to where they used to be."
The impact was immediate for many fixed-income ETFs.
After trading at a discount as deep as 5% to its net-asset value in the week through March 20, the $36.6 billion iShares iBoxx $ Investment Grade Corporate Bond ETF closed at a premium of 3.2% to its underlying holdings last Thursday, while just six bond ETFs ended with a discount of 5% or more. That compares to 37 funds on March 20, according to data compiled by Bloomberg. Meanwhile, 214 fixed-income ETFs closed at a premium.
Easing corporate-default fears have stoked an investment-grade rally after the coronavirus outbreak reignited solvency concerns. While the Fed's pledge of support is a positive, rating downgrades are "inevitable" even with the central bank's backstop, according to Charles Schwab Corp.'s Kathy Jones.
"There's going to be more credit risk than there was a year ago," said Ms. Jones, chief fixed-income strategist at Charles Schwab. "There's going to be some problems from a fundamental point of view, but I think you could wade back into the IG market and say, 'I feel confident with the higher rated companies.'"
