Amid a roller coaster week in the municipal bond market, muni exchange-traded funds set records for trading volume and outflows.
Muni ETFs saw $6.9 billion in market traded value turnover on Wednesday, according to CreditSights, a figure that marked the largest trading volume since the firm started tracking daily ETF data in November 2015.
The funds saw $631 million of inflows on Wednesday following substantial outflows on Monday and Tuesday, said CreditSights senior municipal bond strategist Pat Luby.
The roller coaster ride for ETFs, which are considered an indicator of overall retail demand, followed a
Monday started with some weakness in the muni market, which had likely been amplified by exchange-traded fund selling, exaggerating the weakness in the market through Tuesday and Wednesday, Whitney Fitts, director of municipal portfolio management at Appleton, told The Bond Buyer on Tuesday.
And while Trump announced a three-month pause on his tariff plan sent munis rallying Thursday, the rally was short-lived.
Municipals sold off Friday morning with upward of 30 basis points, depending on the scale, and the selling of ETFs served as a contributor to the severity of the cuts.
"So when ETFs start selling, we see that capitulation going on because we know those bonds have to trade, so it becomes a self-fulfilling prophecy," said Jock Wright, an underwriter at Raymond James. "When ETFs have to sell, they're not going to pick and choose the price; they're going to they have to sell."
"In a liquid environment, that's not a problem. But when you get an illiquid market like we are now, where very few bidders have emerged and good people are going to bid very cheap," he said.
ETFs for the week suffered the largest outflows since muni ETFs began reporting, according to JPMorgan's Peter DeGroot, who said investors pulled out $1.4 billion from ETFs, "the largest weekly outflow since the inception of municipal ETF reporting in 2006."
During times of volatility when the muni market freezes into a notorious lack of liquidity, Luby said that ETFs can play a positive role.
"I think that ETFs help ease the lack of liquidity in the market," Luby said. "It doesn't create visible pressure, because there's not this big list of bonds going out for bids," he said.
"There was selling earlier in the week and net outflows from the ETFs, which means bonds were coming out of the funds in exchange for the shares, but it doesn't create the visibly urgent need to sell bonds to fund shareholders that are leaving," he said. "It's a more methodical and systematic way for bonds to be taken out of a portfolio and returned to the market."
The volatility comes as muni ETFs continue to notch double-digit growth in the muni market. There were 124 muni ETFs as of the end of March, holding $146 billion of assets, compared to 80 muni ETFs totaling $54 billion in assets leading up to 2020, according to Tom Murphy, senior analyst on Morningstar's fixed-income team.
On Monday, Fidelity became the latest firm to enter the municipal bond ETF space, with two ETFs that were conversions from open-end mutual funds. Fidelity declined to comment.
ETFs made up
The growth of ETFs over the last 10 years has been "exceptional," said Sean Carney, head of municipal strategy at BlackRock,
"I could certainly see ETFs overtaking the mutual fund space in the next couple of years," Carney said.
"As they grow, investors in municipal bonds need to adjust their ideas of volatility," said Michael Pietronico, CEO at Miller Tabak Asset Management.
"If you get an asset class like ETFs becoming a larger part of the market, you're going to get more price swings on a daily basis than you've ever seen in a conservatively run market like municipals," Pietronico said.
"Anytime you get a market of 50 basis points in a day, the bulk of that move is being driven by fast money and the fast money is in ETFs," he said. "It's the ETFs with help from the mutual funds," he added.
The "inefficiencies" of ETFs can "lead to higher volatility," Dan Solender, a partner and director of tax free fixed income at Lord Abbett warned in a
As "the outlook gets uncertain, the prices of muni ETFs can fall to substantial discounts to their NAVs causing dislocations," Solender wrote. "Overall, the higher volume of selling from ETFs on April 7 contributed to increased liquidity costs, causing municipals to underperform compared to Treasuries."
Despite the wild moves and illiquidity, the market didn't feel as panicked as during COVID-related selloffs, several buysiders said. That's likely because the tariff uncertainty isn't expected to hurt credits, at least not yet.
"What I'm hearing from managers is that fundamentals remain strong, and we're not seeing deteriorating credit quality despite the outside pressures from tariffs and tax policy," Morningstar's Murphy said.
Jessica Lerner contributed to this story.
