A recent report by ratings agency Fitch highlights the growing use of exchange-traded funds as the investment vehicle of choice for investors wishing to trade in the high-yield bond market. The increase in popularity of these funds is due to a combination of limited liquidity in underlying high-yield bond markets, combined with the growing importance of liquid investments to safeguard against current uncertain interest rate movements and dynamic macro fundamentals.

High-yield ETF investors tend to seek liquidity during periods of volatility, according to a recent report by Fitch.

High-yield ETF investors tend to seek liquidity during periods of volatility. On 24 August 2015, against the backdrop of sharply falling global stock prices, the dollar volume of high-yield ETF trading reached a daily record of 32% of the trading volumes of the underlying high-yield bond market. This occurred despite ETF assets representing only 4% of high-yield bonds outstanding. During the same week, trading of high-yield ETFs reached a weekly average high of 19% of high-yield bond trading.

The previous high occurred in October 2014, during the Treasury market flash crash and broader market volatility.

The increase in high-yield ETF trading volume this year is even more extraordinary given that it occurred against a backdrop of decreasing assets. From the end of February 2015 until the end of August, high-yield ETF assets decreased from $39.9bn to $33.2bn due to redemptions, as well as market value declines.

Some of the largest and most liquid US-listed high yield ETFs include the SPDR Barclays High Yield Bond ETF (JNK), with over $9.2bn in assets under management (AUM); the iShares iBoxx $ High Yield Corporate Bond ETF (HYG), which currently holds over $13.0bn in AUM; and the Vanguard High-Yield Corporate Fund Admiral Shares (VWEAX), boasting AUM of over $13.9bn.

Interestingly, there is a noted disparity between the trading volumes of high-yield ETFs and those tracking investment grade bonds. The high-yield ETF market tends to trade far more frequently despite being half the size of the investment grade ETF market. Investment-grade ETF daily average trading volume of $670m year to date is 35% less than the daily average of $1bn for high-yield bond ETFs. The difference is, according to Fitch, indicative of the greater willingness to adopt a buy-and-hold strategy in the investment-grade ETF market than in the high-yield one.

Fitch has also warned that the change in high-yield trading volume could create the potential for price disconnects or forced selling in the underlying high-yield bond market. Many holdings of bond ETFs do not trade every day, compared to ETFs, which trade frequently throughout the trading day. Investors are relying more heavily on ETFs to gain exposure to the high-yield market, and quick shifts in risk appetite can lead to an increase in redemptions. Major outflows could cause fund managers to liquidate assets at unfavourable prices to meet redemption demands. This could depress prices of illiquid bonds and hurt fund performance.