03.25.2013
By Terry Flanagan

Going With the Flow as Liquidity Picks Up in Europe

The elusive search for liquidity in Europe continues for buy-side traders.

With the advent of high-frequency trading, increased automation and a host of new trading venues popping up in the region over the last decade, trading volumes exploded and peaked at record levels in early 2009 before heading on a downward path. But despite recent signs of a pick-up, liquidity is still way down on these 2009 levels in many European equity markets.

Andrew Parry, chief executive, Hermes Sourcecap

Andrew Parry, chief executive, Hermes Sourcecap

“We need liquidity,” said Andrew Parry, chief executive of Hermes Sourcecap, a U.K.-based asset management firm. “We need to make sure there is ample liquidity and ample venues for liquidity.

“Without liquidity you just bring volatility. That is what we know about illiquid markets as it amplifies periods of difficulty in times of crisis. We need a whole different variety of trading to take place.”

The 2013 trading year, though, has started on a positive note and has so far been characterized by a rip-roaring start to the year for equities that has added much-needed liquidity to the markets.

“Right now, the search for liquidity isn’t hard,” said Toby Ricketts, chief executive of Margetts Fund Management, a U.K. investment boutique which specializes in managing risk rated multi-manager funds.

“But it could dry up remarkably quickly. You might not be worried about liquidity today but you have to be careful what sort of assets you are going to hold because liquidity might not be there.

“You have seen over the last few summers where liquidity has become more difficult especially on the small and mid-caps or where there has been specific concerns about Europe, but liquidity has generally been improving in the last six months or so.”

Ricketts added: “Future liquidity has to be one of the factors you take into account on everything you hold at the moment otherwise you could find yourselves in a liquidity crunch. And for all the rises in prices recently, liquidity is still quite tight.”

Issues surrounding liquidity have also been uppermost in the minds of many in the hedge fund sphere.

“Liquidity can be viewed from many different angles from the terms of hedge funds to the liquidity of underlying markets,” said Najy Nasser, chief investment officer of Headstart Advisers, a London-based hedge fund.

“Undoubtedly markets have become less liquid with banks exiting their proprietary businesses, acting as pure brokers rather than holding inventory. On the whole, hedge fund managers have learned a great deal from the 2007-2008 period and the liquidity of their structures and the underlying holdings have become more aligned, going some way to alleviating the liquidity mismatch that became so pronounced in late 2008.

“Many hedge fund managers are able to actively take advantage of the search for liquidity through a return to active trading and thus becoming a provider of liquidity in times of stress.

“From the hedge fund perspective and, in particular the fund of hedge fund perspective, it appears that many investors especially in Europe are increasingly requiring very liquid terms from hedge funds.

“We have seen an increased push for daily and weekly liquidity funds and this, in our view, certainly comes at the expense of performance. Our approach is that hedge funds are primarily longer-term investments and when we select a fund for our portfolio, in the majority of cases, this is expected to be a multi-year investment.

“The most significant case in our opinion against highly liquid terms for hedge funds is that the higher pedigree managers will be able to raise assets with more stringent terms that provide them with security to build a suitable and importantly a sustainable business model.

“The managers that therefore offer very lax investment terms often not aligned to their assets or investment strategy are predominantly second tier managers seeking assets which compound their disadvantage through a lack of a stable capital base.”

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