Beyond Creation and Redemption: Principal Trading by Bond ETFs

Authors

Alan Guoming Huang, University of WaterlooFollow
Maureen O'Hara, Cornell University - Samuel Curtis Johnson Graduate School of Management; Cornell University - Cornell SC Johnson College of BusinessFollow
Jinming Xue, Southern Methodist University (SMU) - Finance DepartmentFollow
Xing (Alex) Zhou, Southern Methodist University (SMU) - Finance DepartmentFollow

Publication Date

11-17-2025

Abstract

We investigate principal trading in corporate bond ETFs. While rare in equity ETFs, we show that principal trading by bond ETF managers is widespread, occurring on 35% of trading days, more often than either creations or redemptions. Adjusted for ETF size, volumes of principal trading and creation/redemption are comparable. Because bond ETFs hold more issues and face maturities, redemptions, and credit migrations, we show how principal trading allows passive bond ETF managers to more effectively align bond holdings and reduce tracking error. Principal trading also increases portfolio alpha for active ETFs by 25 basis points.

Document Type

Article

Keywords

Corporate Bond, Principal Trading, Creation and Redemption, Tracking Error, Fund Performance, ETF

Disciplines

Finance

Source

SMU Cox: Finance (Topic)

Language

English