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Investors are turning to ETFs in the face of a bond market left shaken by uneasiness over the Fed's tapering of quantitative easing.
Mutual fund managers, pension funds and registered investment advisers have been turning increasingly to exchange-traded bond funds to protect them should fixed-income markets turn nasty. Since May managers have been able to test the theory that ETFs allow them to better maneuver illiquid and volatile markets. That was the month, of course, when Federal Reserve chairman Ben Bernanke signaled to the markets for the first time that the Fed was preparing to taper its $85 billion in monthly bond purchases, which have kept interest rates at historic lows and fired up international markets. Bernanke's remarks sent rates rising, bond prices plunging and investors redeeming their bond funds. Though the Fed has since announced a delay in tapering until there are more signs of solid recovery, the bond markets remain in flux. (Read more: "Investors Hinge ETF Strategy on Fed Tapering Timing")
While investors' unease complicates matters, the added volatility stresses the market trading structure for fixed-income securities. Bonds still primarily trade hands in a principal-based market that requires dealers to commit capital to facilitate trading. But a combination of new regulations, stricter capital requirements and risk aversion has prompted banks to pull back from the business of fixed-income trading. To get around hobbled bond markets, investors have been using ETFs, mostly indexed funds in asset classes such as high-yield and investment-grade corporate bonds....