Solving The Bond ETF Discount Problem

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Solving The Bond ETF Discount Problem

Postby Rick Ferri » Thu Jun 27, 2013 1:22 pm

Bond exchange-traded funds can be tricky to trade at times. Although these securities trade within a reasonable range of their net-asset value (NAV) most days, there are those periods when the ETF market just doesn’t want to cooperate. Last week was a good example. Here are two ways to solve this problem.

Solving The Bond ETF Discount Problem

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Re: Solving The Bond ETF Discount Problem

Postby indexfundfan » Thu Jun 27, 2013 1:34 pm

Rick Ferri wrote:Bond exchange-traded funds can be tricky to trade at times. Although these securities trade within a reasonable range of their net-asset value (NAV) most days, there are those periods when the ETF market just doesn’t want to cooperate. Last week was a good example. Here are two ways to solve this problem.

Solving The Bond ETF Discount Problem

Rick Ferri


I thought the article was really going to discuss how the problem can be fixed. Basically it just says to either not use bond ETFs or not to perform any transactions.

Similar example:

"How to solve the high expense ratios in specialty ETFs"

Solution: do not use them.
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Re: Solving The Bond ETF Discount Problem

Postby SnowSkier » Thu Jun 27, 2013 1:59 pm

Couldn't this be a good thing, if you were buying a bond ETF when everyone else was selling? Seems like you would add to your bond allocation (if you wanted to) at a price less-than-NAV?
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Re: Solving The Bond ETF Discount Problem

Postby MnD » Thu Jun 27, 2013 2:06 pm

If I was in the market for muni bonds I would have all over the muni bond ETF's last week.
Or tax-loss harvesting with a "kicker" - sell a mutual fund with an unrealized loss at closing NAV and buy a similar ETF same day right before the close at a significant discount to NAV.
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Re: Solving The Bond ETF Discount Problem

Postby ogd » Thu Jun 27, 2013 2:08 pm

Some of us did just that -- see this thread: viewtopic.php?f=10&t=118462&newpost=1734249 . It's worked out well. Strong hands can be an advantage at times.

Now I have a capital gains problem instead, in an ETF I don't really want to hold :greedy
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Re: Solving The Bond ETF Discount Problem

Postby baw703916 » Thu Jun 27, 2013 2:20 pm

It would be really good if brokers let you enter conditional orders for ETFs based on % discount to NAV. But I'm not sure there's a straightforward way for individuals (as opposed to Authorized Participants) to do that.
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Re: Solving The Bond ETF Discount Problem

Postby chipmonk » Thu Jun 27, 2013 2:28 pm

SnowSkier wrote:Couldn't this be a good thing, if you were buying a bond ETF when everyone else was selling? Seems like you would add to your bond allocation (if you wanted to) at a price less-than-NAV?

Sure, this is what ogd and I did :)... but at its root, we only got this good deal because we're exploiting the ignorance/fear of all the counterparties who are selling off their bond ETFs, without realizing that the ETF's price has become unmoored from its NAV due to the lack of liquidity of the underlying asset. So in the long run I think this problem with bond ETFs will simply undermine trust in them as an investment vehicle, hurting everyone who uses them... :(If I was in the market for muni bonds I would have all over the muni bond
MnD wrote:ETF's last week.
Or tax-loss harvesting with a "kicker" - sell a mutual fund with an unrealized loss at closing NAV and buy a similar ETF same day right before the close at a significant discount to NAV.
This is precisely what I did, thanks to ogd's helpful advice in the thread he linked to. Made ~3.5% in 3 days by swapping VWLUX for HYD, and it would've been closer to 10% if I'd bought on Monday and held on to it until today rather than selling yesterday.
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Re: Solving The Bond ETF Discount Problem

Postby patrick » Thu Jun 27, 2013 6:11 pm

indexfundfan wrote:Similar example:

"How to solve the high expense ratios in specialty ETFs"

Solution: do not use them.


That sounds like a good plan to me.
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Re: Solving The Bond ETF Discount Problem

Postby Jack » Thu Jun 27, 2013 6:38 pm

"
How to solve the high expense ratios in specialty ETFs"

Solution: do not use them.

This may not be the solution you think it is. It only raises the bigger question of why you would trust the NAV any more than you would trust the ETF price. The NAV is calculated from the price of most recent trades, but if there is illiquidity, that calculation could also be distorted. The "real" price may be somewhere between the NAV and the ETF. All you know is that at some point they will converge. You could be paying a discount or premium when purchasing the regular mutual fund just you would for an ETF, except in the case of the mutual fund it wouldn't be as obvious. This would suggest being careful of trades in either bond mutual funds or bond ETFs when there is volatility suggested by divergence of NAV and ETF prices.
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Re: Solving The Bond ETF Discount Problem

Postby livesoft » Thu Jun 27, 2013 7:43 pm

It reads to me like you want to buy bond ETFs on "risk-off" days to take advantage of the temporary lower-than-NAV anomaly.

Maybe the moderators can change the thread title to "Taking Advantage of the Bond ETF Discount Problem".
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Solving The Bond ETF Discount Problem

Postby baw703916 » Thu Jun 27, 2013 8:21 pm

Actually, the thought crossed my mind last week to look into municipal bond CEFs--but I doubt there are any that aren't leveraged, high E/R pieces of junk with low-quality portfolios. Does anybody know any exceptions?
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Re: Solving The Bond ETF Discount Problem

Postby stlutz » Thu Jun 27, 2013 11:13 pm

This may not be the solution you think it is. It only raises the bigger question of why you would trust the NAV any more than you would trust the ETF price. The NAV is calculated from the price of most recent trades, but if there is illiquidity, that calculation could also be distorted.


I agree. I would argue that the ETF price is a better representation of the actual market value of the underlying securities as it is based on real trades and not pricing models.

That doesn't change the good advice that Rick gives, however. I would just view the fund as offering a bit of a free lunch a times and the warning against trading in volatile markets is also good advice.
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Re: Solving The Bond ETF Discount Problem

Postby Best of Both Worlds » Fri Jun 28, 2013 4:08 pm

MUNI ETF was down .90% today. I personally own VWIUX and was wondering whether I can expect a similar decline in price today as well. Yields were not up today so I am a little confused as to this decline. Is it possibly premium/discount related?
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Re: Solving The Bond ETF Discount Problem

Postby Rick Ferri » Fri Jun 28, 2013 4:19 pm

Best of Both Worlds wrote:MUNI ETF was down .90% today. I personally own VWIUX and was wondering whether I can expect a similar decline in price today as well. Yields were not up today so I am a little confused as to this decline. Is it possibly premium/discount related?


Municipals, high yield and investment grade corporate bond ETFs are down today. It could be related to adviser/manager window dressing on the last trading day of the quarter. Some advisers/managers play a hide-and-seek game with clients by selling losing positions on the last day of a quarter, then make believe they never owned them. The losing position doesn't show up on a client's quarterly valuation report, which is based on end of the day holdings.

You may say, "Do advisers think client's are that stupid?" The answer is, yes. Some advisers do believe their clients are that stupid or are not paying attention. There is ample evidence to prove this. Just look at all the people who are paying advisers 1% or more to unsuccessfully market-time or pick actively managed investments. Those folks ARE being taken to the cleaners by their advisers because they don't know any better.

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Last edited by Rick Ferri on Fri Jun 28, 2013 7:28 pm, edited 2 times in total.
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Re: Solving The Bond ETF Discount Problem

Postby Best of Both Worlds » Fri Jun 28, 2013 4:22 pm

Rick Ferri wrote:
Best of Both Worlds wrote:MUNI ETF was down .90% today. I personally own VWIUX and was wondering whether I can expect a similar decline in price today as well. Yields were not up today so I am a little confused as to this decline. Is it possibly premium/discount related?


Municipals, high yield and investment grade corporate are down today. It could be related to adviser/manager window dressing on the last trading day of the quarter. Some advisers/managers play a hide-and-seek game with clients by selling losing positions on the last day of a quarter, then make believe they never owned them. The losing position doesn't show up on a client's quarterly valuation report, which is based on end of the day holdings. You may say, "Do advisers think client's are that stupid?" The answer is, "Yes, some advisers do believe their clients are that stupid."

Rick Ferri


Yes, I am familiar with window dressing. So, can I expect a similar decline in VWIUX as well? BIV was down .02%
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Re: Solving The Bond ETF Discount Problem

Postby Rick Ferri » Fri Jun 28, 2013 4:25 pm

I doubt traditional muni funds will be down much today. The window dressing happens in the ETF market. Someone puts in a large order to buy or sell at the end of the day and this affects prices. With MUB, there was a large sell order about 2:45 and then buying started back up. This caused about a 0.7% swing in the price in 30 minutes. This was a trade related issue. The entire muni market did not move that much in such a short period.

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Last edited by Rick Ferri on Fri Jun 28, 2013 7:22 pm, edited 1 time in total.
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Re: Solving The Bond ETF Discount Problem

Postby Best of Both Worlds » Fri Jun 28, 2013 4:35 pm

MUNI ETF traded down over .75% for most of the day. Also, is VWIUX considered a closed-end fund? I didn't think that CEF applied to this fund. Do you use the term because it is closed to new investors? Thanks for the education.
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Re: Solving The Bond ETF Discount Problem

Postby Rick Ferri » Fri Jun 28, 2013 4:38 pm

Vanguard Intermediate-Term Tax-Exempt Fund Admiral Shares (VWIUX) is an open-end fund. Shares are created and redemed once per day by Vanguard at NAV. The fund is in a unusual "partial" close state. It's only open to new investors who buy directly from Vanguard. It's not open to new investors who custody at Schwab, Fidelity, or any other brokerage firm.

A closed fund and a closed-end fund are two different things. A closed fund is either 1) closed to new investors, or 2) a fund that has liquidated. A closed-end fund is a type of fund structure under the Investment Company Act of 1940.

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Re: Solving The Bond ETF Discount Problem

Postby Best of Both Worlds » Fri Jun 28, 2013 5:18 pm

Thanks Rick. I'll know shortly whether to use MUNI intra-day as a proxy for VWIUX end of day pricing.
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Re: Solving The Bond ETF Discount Problem

Postby ogd » Fri Jun 28, 2013 5:30 pm

Rick Ferri wrote:I doubt closed-end muni funds will be down much today. The window dressing happens in the ETF market. Someone puts in a large order to buy or sell at the end of the day and this affects prices. With MUB, there was a large sell order about 2:45 and then buying started back up. This caused about a 0.7% swing in the price in 30 minutes. This was a trade related issue. The entire muni market did not move that much in such a short period.

Rick Ferri

Rick, when I was researching muni ETFs I did read somewhere that the construction of MUB is such that it makes share creation more difficult, so it has higher P/Ds. I can't remember that original reference, but a Google search now turned up: http://seekingalpha.com/article/384861- ... -bond-etfs

When I look up the P/D history at Schwab, it confirms that MUB has consistently high premiums. Perhaps it's not the best one to use as an indicator.
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Re: Solving The Bond ETF Discount Problem

Postby Best of Both Worlds » Fri Jun 28, 2013 6:12 pm

VWIUX NAV unchanged for 6-28.
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Re: Solving The Bond ETF Discount Problem

Postby Rick Ferri » Fri Jun 28, 2013 7:21 pm

Best of Both Worlds wrote:VWIUX NAV unchanged for 6-28.


Well, imagine that. :wink:

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Re: Solving The Bond ETF Discount Problem

Postby louis c » Sat Aug 31, 2013 10:37 am

These are two articles that present the idea that when owning bond funds for the long term, owning ETFs is actually better than owning the open ended mutual fund. The bottom line of the argument is that bond markets are illiquid, and therefore redemptions of open ended funds are at prices based on pricing services, not actual trades, and therefore long term owners are paying sellers a "subsidy" - that is paying sellers prices higher than they should be getting if actual sales of the underlying bonds were made. Assuming the ETF has a low expense ratio, it kind of makes sense to me, but it may not apply to Vanguard since both ETF and open market versions are pooled to the same portfolio of bonds. Any contrary opinions out there?

Here are the articles - pretty interesting read:

http://seekingalpha.com/article/1600982 ... oogle_news

http://www.indexuniverse.com/sections/b ... =1&start=3
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Re: Solving The Bond ETF Discount Problem

Postby Rick Ferri » Sat Aug 31, 2013 1:00 pm

There's also a strategy that sells short bond ETFs when they are at a premium and buys funds, then sells funds and buys ETFs on big down days. It all makes sense - in theory. I don't see anyone retiring to the French Riveria doing this.

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