Bond Liquidity Picks Up

Terry Flanagan

Bond market liquidity is beginning to pick up following a prolonged period of stagnation.
“We are able to work orders and get more volume done in a day because it’s a little more of a two-sided market, where there are divergent views whether some investors think spreads are fully priced, and other investors have more cash and are looking to invest,” said Wes Sparks, head of U.S. fixed income at Schroders Investment Management.

Sparks added, “Recently, liquidity has been good, but as we’ve seen repeatedly since 2008, liquidity can be ephemeral, and can shift to being a problem on the bid side, to where right now the more challenging thing is to get money to put to work on secondary trading, so the offer side is more challenging in that dealers don’t have a lot of inventory.”

Demand for investment grade corporate bonds from pension funds and insurance companies increased in the second half of 2013 after yields increased from the May lows, more than offsetting the net outflows experienced by mutual funds.

Supply in 2014 is expected to be at similar levels to 2013 after adjusting for upcoming redemptions, according to Sparks. “Most companies have taken advantage of low yields to pre-fund upcoming debt maturities,” he said. “Acquisition-related bond issuance is likely to increase in the coming year, but leveraged buy-out (LBO) activity should remain more subdued than M&A and IPO activity in 2014.”

Sparks said that both investment grade and high yield supply was less than expected from November through the second week in January. “The market has been a little more volatile over the last three weeks,” he said. “I was hoping for more of a correction in spreads to get excited about buying, but in the last three days the markets have improved, so we’ve been selectively buying new issues. In mid-January, we were selling to create some dry powder because we expected the new issue calendar to heat up. So far that hasn’t materialized.”

Sparks focuses mainly on corporates, but also is seeing some opportunities within other fixed income sectors such as asset-backed and municipals. “We have a team of a dozen portfolio managers and we are all sector specialists,” said Sparks. “There are several other portfolio managers who specialize in high-yield, we have two portfolio managers and a couple of traders in investment grade, three securitized specialists, a couple of portfolio managers on the government side, and a couple on the municipal side.”

The Schroders portfolio managers sit literally across the desk from traders, and the teams continually exchange ideas.

“We’re talking to one another throughout the day,” Sparks said. “I often get ideas from my own traders, because they’re talking to other traders and salespeople, and vetting ideas with the analysts. It’s a three-legged stool: the credit analyst, trader, and portfolio manager vetting ideas on potential upside and downside. My interactions with the traders are very much about the technicals in the market, and getting valuations on comps.”

Especially in high yield, electronic trading platforms are not a big component of the business, he noted. “There are a lot of credits we own where the lead underwriters will know who the investors are,” he said. “I think there is real value to the traditional model of Wall Street with a sales and trading force.”

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