Best Ideas 2019 Preview: Why We Are Short Bond ETFs

This article is authored by MOI Global instructor Adam J. Schwartz, Chief Investment Officer of Black Bear Value Partners, based in Miami, Florida.

We are short a variety of bond ETFs (exchange-traded funds) encompassing high-yield, investment grade, emerging market, emerging market high-yield and bank debt. Structures with daily liquidity were not created for illiquid securities such as bonds and bank debt. The underlying assumption is the market-marker will stand in the middle to provide liquidity. Systems/markets have an underlying “trust” component to them. It is hard to predict how things play out if the market makers lose confidence in the liquidity of the underlying cash bonds.

As a lender with limited upside bond investors should be exercising caution and prudence when possible returns are low. Unfortunately, this is the opposite of human behavior and as investors stretch for yield, they expose themselves to potentially catastrophic risk. Recent fixed-income investors may be borrowing from tomorrow to have their coupons paid today.

Two charts from Moody’s that highlight some of my concerns are below. In a nutshell we have:

• more debt
• with an expectation for historically low corporate defaults
• and are taking reduced returns as compensation

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