Monday, 16 July 2018

Time to think again

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SwissInvest strategist Anthony Peters considers what a lack of bond market liquidity means for the buyside.

Anthony Peters

Anthony Peters, SwissInvest strategist

I HAPPEN TO have a friend who has taken the unusual step of moving back into the high-intensity world of a banking job after a period in the more sedate environment of institutional portfolio management.

He runs the credit research group for a major European banking entity. And although we don’t speak regularly, we do catch up from time to time and I always take note of his incisive observations on life, the universe and everything (including, funnily enough, fishing).

We had another of our thoroughly good chats last week. It started with my wishing to plug into his thinking with respect to Peugeot, the troubled French automaker, and its chances with or without that putative injection of Chinese capital, but quickly moved on to the state of the European credit markets – in particular, the growing divergence between primary and secondary markets.

He told me how, when he speaks to institutional clients whom he visits on a regular basis, he asks how they are handling the miserable to non-existent liquidity in the secondary market. Have they, he asks, become simple buy-and-hold investors? Apparently, the answer is primarily affirmative.

Am I surprised? Not at all – the bond market as we knew it has pretty much ceased to exist.

My colleague Keith Mullin, IFR’s editor-at-large, wrote a very eloquent piece in this magazine last week in which he acknowledges the difficulties that the markets are undergoing in terms of liquidity but concludes that the problems are of a cyclical nature, rather than a chronic malaise.

Myself, I am convinced that, like with coal mines, the mother lode has been exhausted and although there is a living to be made from exploiting the subsidiary lodes, the work is twice as hard for much lower yields. And in broad terms, the mines are closing and will not reopen.

The buyside still hasn’t worked out what it wants to be when it grows up

THE SELL-SIDE seems to be rapidly adapting to this brave new world, but the buyside is struggling.

I can sympathise with trustees of a pension fund who, having chosen an asset manager to tend their money, do not want to have that same company declaring that the world has changed and that the finely-tuned terms upon which the mandate was awarded are now more of a hindrance than a help. But it will soon become necessary for many investment management mandates to take into account the changed environment.

In other words, in the same way in which irrational belief in the infallibility of mathematical modelling abjectly failed the banks in the 2007–08 crisis, so it is now beginning to cause the investment firms a few headaches too. It is, for instance, hard to trade around the core of an index if trading is dysfunctional.

IN THE GLORY days of the Eurobond market, there was a symbiotic relationship between lead managers, their dealers and their largest clients. The investors would take down blocks of bonds and then, as the deal became more firmly placed, gently feed bonds back to the Street, thus managing and maintaining supply to the market and subsequent liquidity too.

Those involved failed to do that at their peril – if a bond issue could not be sensibly traded, it would “go illiquid”, be taken off the front book and spreads would be widened to reflect the zombie status and hence the undesirability of the issue.

The emergence of CDS brought this to a halt, as it was, for some inexplicable reason, assumed that any bond for any credit could be assigned a generic price wrapped around the quotes for the derivative. That process has added illiquidity rather than liquidity, but that’s a subject for another day.

What is sure is that the market environment has significantly changed and the buyside still hasn’t worked out what it wants to be when it grows up.

Generic still outstrips idiosyncratic when it comes to assessing and managing risk. Maybe that isn’t the way to do things but if offered the choice between leading the charge in changing investment management culture or raising the Titanic, I’d choose the latter as the easier option every time.

Meanwhile, investment management firms will absorb large blocks of bonds in the clear knowledge that they will not be able to sell them whether times are good or bad. Has anyone got a bid for a block of 35,000,000 Peugeot bonds please? Oh, I didn’t think so.

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