Most bonds trade between dealers, not on an exchange. Many issues do not trade on a given day.
So a bond fund’s net asset value (NAV) rests on estimated prices from pricing services.
The ETF itself trades all day on an exchange. In a sell-off, its price can move first.
March 2020
In mid-March 2020, some of the largest investment-grade and high-yield corporate bond ETFs recorded discounts to NAV of more than 5%.
In January those discounts had been no larger than 0.1%, the Bank of England reported in May 2020.
Trading in the largest U.S. investment-grade corporate bond ETFs ran at more than three times its January average in March.
The Bank found ETF prices took in new information faster than the funds’ NAVs.
Why redemption does not close the gap at once
An authorized participant (AP) can redeem shares for a slice of the bonds. In a sell-off it must then sell those bonds into a thin market. That cost shows up as the discount.
Both sides of the trade
A seller at a discount receives less than NAV says the bonds are worth.
A buyer at a discount pays less, but the gap can widen before it closes.
The fair limit is midpoint + X¢ to buy, midpoint − X¢ to sell.
X is half the fund’s typical spread in cents, rounded up, and never less than 1¢.
The premiums guide covers the gap in calmer markets.