Bond Fund’s Assets Shrink 88% in 1 Day

Monday, October 10, 2016

Sheila Jamison and Rich Jamison

Franklin Templeton Investments (FT) held almost all of WisdomTree’s Australia & New Zealand Debt ETF (AUNZ). The fund has returned over 12% this year when both Australia and New Zealand bonds rallied after their central banks each cut another 50 basis points. That took their sovereign interest rates to record lows.

However, the recent selloff in global debt markets has seen yields rebound. Rising interest rates have hurt returns for fixed-income investors. Specifically, Australia’s benchmark 10-year bond rate stood at 2.13% in Sydney last Wednesday, 31 basis points above its August 2 low. The comparable New Zealand rate has climbed 35 basis points to 2.47% since its August 11 low.

FT, seeing the increase occurring in rates, thought it was time to get out of the ETF before they got hurt by the ETF’s price declines from drops in its underlying bonds. Thus, FT “sold” all its shares during the last week in September. However, “selling” an ETF for anyone with enough money isn’t the same as it is for the average investor. Instead of selling ETF shares on the open market, big investors (each called an authorized participant, or AP) go to the ETF’s provider directly. Essentially, they say, “Here are your ETF shares (usually requires blocks of at least 50,000 shares). Give me the underlying assets.”

The ETF takes back the shares and hands over the assets, in this case, the bonds. Then, the AP can sell the bonds on the open market in as they deem best.

The question that probably comes to mind is “so what?” Here’s that answer in two parts:

The first part is that by selling when it did, Franklin Templeton locked in their gain* by selling the bonds before interest rates climbed further. For example, they avoided the ETF’s 1.1% tumble on this past Tuesday, its biggest decline in three weeks.

The second – and critical – part is a little bit more involved. Market sale of those assets lowers their price when the supply for sale exceeds the demand to buy. FT pulled over $130 million in assets out of the WisdomTree fund in one day (September 28th), leaving only $19 million in the ETF.**

When Franklin Templeton sells (sold) those assets, it can lower the selling price for them (the law of supply and demand). Because what is left in the ETF is more of those same assets, the ETF price may fall. Last Tuesday’s drop in the Wisdom Tree ETF may turn out to be only the tip of the iceberg.

ImageThe chart of that fund since FT exchanged its shares for the bonds themselves on 9/28 from finance.yahoo.com) reminds us once again of how quickly bond funds can react to interest changes.

* Bloomberg reports FT invested the proceeds in assets with less exposure to interest-rate risk, such as investment-grade credit and gold. We wonder how they liked gold’s performance last week. See Week in a Nutshell: Executive Summary.

** WisdomTree’s Australia and New Zealand fund invests in debt denominated in those countries’ currencies that is primarily issued by governments and supranational agencies, the data show. Franklin Resources Inc., the Canadian manager’s parent, owned nearly eight million shares in the WisdomTree ETF worth almost $138 million at the end of June, regulatory filings show.

One Big Sale by Franklin Templeton Gutted Australia-Debt ETF. Rachel Evans. Bloomberg.com. October 5, 2016.
What Is The Creation/Redemption Mechanism? Staff. Etf.com. Retrieved October 8, 2016.