I have a question about how ETFs handle holdings in the event of a default. Many corporate bond trusts that I’m familiar with simply close out the trust, liquidate the holdings and distribute the remaining funds to current holders. That locks in losses and doesn’t allow holders to wait it out for any eventual recovery. What about bond funds and ETFs?
Specifically, I’m wondering about Treasury ETFs like BIL or TLT. I hold individual short term treasuries, but I’ve also been looking at Treasury ETFs. My concern is the upcoming debt limit vote and whether or not our esteemed elected officials use the political nuclear football to its endgame and force some kind of a short term default scenario. With actual Treasuries, I’m confident that they’d have to resolve the issue and there would eventually be little impact (my longest duration now is 9 mos). But what would the impact be on bond funds and ETFs? (I’m more concerned with ETFs.) Do their rules allow them to hold bonds that are in default, and might they be forced to sell Treasuries that are technically in default if Washingtoon drops the ball?
I have an email in on this question to Blackrock regarding TLT. It’s been fired off into the abyss. If I do hear anything, I’ll post the answer in case others are interested. The prospectus was not much help.
I did eventually receive a reply and thought I’d post it in case anyone else is interested. As I understand it, in the event of a technical default and a fall in the index, the ETF would sell into the trend and match the index. In retrospect, this isn’t surprising. However, it’s definitely not in the interest of anyone that holds this as an investment. I won’t be considering any bond ETFs as investments.
Thank you for contacting Blackrock, Peter.
We would be happy to provide some assistance and apologize for the delayed response.
Our iShares ETFs, like TLT, are passively managed, with this particular fund tracking the ICE US Treasury 20+ Year Index (USD). With passively managed funds, the goal is to track the benchmark as accurately as possible, and not to outperform.
Please refer to page 13 of the PDF in the attached prospectus, listed under “Issuer Risk”, “The Fund may be adversely affected if an issuer of underlying securities held by the Fund is unable or unwilling to repay principal or interest when due.”
If you have any follow up questions on iShares products, please call 1-800-iShares (474-2737) between 8:00 a.m. and 6:00 p.m. Eastern Time Monday through Friday and we will attempt to assist.
The iShares Service Team.