Bond market liquidity: one for the ages

Like a parade of music’s greatest hits, the past year in markets has been crammed full of noise.

Some of it is pointless static, but other market melodies could turn out to be as important as Dark Side of the Moon, Thriller, Nevermind and 3 Feet High and Rising. Well, to bond nerds like me, that is.

Equity investors have been lambasting record low volatility and worrying about complacency in the marketplace, I believe equity markets are actually very volatile – just in a different way than people are used to. There has been a double-digit correction in the FTSE All-Share every year since the global financial crisis. Sometimes more than one. Volatility – when it arrives – appears to be getting turned up to 11.

Share markets are not your typical entertainment for a bond fund manager, but I think it’s important to be sensitive to one of the true global measures of business and consumer sentiment. At the moment, the share market’s mood reminds me of the famous line from former-Citigroup chief Chuck Prince: “As long as the music is playing, you’ve got to get up and dance.” Citigroup made huge writedowns within months of his remark.

For all the retrospective pillorying of Mr Prince, he’s right: no-one knows what will happen in the future and there are risks to staying on the sidelines. If you refuse to invest until there is zero uncertainty, you would never invest and would lose your capital to inflation.

Bond markets are seeing similar pressures, but with arguably greater distortions from quantitative easing and forced purchases by pension funds for regulatory reasons. US treasury market volatility – or at least the best measure of it, the Merrill Lynch MOVE Index – is extremely low right now too.

In the corporate bond arena, liquidity has taken a large step down in the past few years. Dealer inventories have roughly halved from 2011 levels, and are on a completely different scale compared with what banks used to hold before the global financial crisis. With fewer bonds available and market makers less inclined to take overnight positions, spreads are now much wider than they used to be, potentially depressing trading further.

This duet of influences – a downward pressure on yields from monetary policy and lesser trading – could be leading to dampened volatility. Investors may be less inclined to sell holdings because of the greater difficulties in doing so. Added to this, recently the spread above government debt for non-financial bonds has been accounting for between 60% and 80% of the yield. That means making the right call on the creditworthiness of issuers is more crucial than ever, because any deterioration is likely to significantly hit your mark-to-market returns. Investors are incentivised to be more long-term in their investments and are less likely to change positions than perhaps they were in the past.

Meanwhile, an overriding strain running through bond markets is a lingering sense of unease. For some time now, most bond fund managers’ portfolios have been much shorter duration – and therefore less sensitive to yield changes – than in the past. Despite this stance, duration has actually provided strong returns over the last couple of years. Whether this was worth the risk they represented is another matter, however.

No-one knows when the music will change and what the tempo will be when it does. But it feels to me like this era of market tunes may turn out to be essential listening for future investors.

Important legal information

This area of the site is for professional advisers

Please read this page before proceeding, it explains certain legal and regulatory restrictions applicable to the distribution of this information. It is your responsibility to inform yourselves of and to observe all applicable laws and regulations of the relevant jurisdiction.

This section of the website is directed only at investment advisers and other financial intermediaries who are authorised and regulated by the Financial Conduct Authority (FCA).

The information provided in this site is directed at UK investment advisers only and must not be circulated to private clients or to the general public. It does not constitute an offer to sell, or solicit an offer to purchase any investments by anyone in any jurisdiction in which such offer or solicitation is not authorised or in which a member of the Rathbone Group is not authorised to do so.

I confirm that I am an investment intermediary authorised and regulated by the Financial Conduct Authority. I have read and understood the legal information and risk warnings below:

Important Information (Terms and Conditions)

The information contained on this site is believed to be accurate at the date of publication but no warranty of accuracy is given and the information is subject to change without notice. Any opinions or estimates included herein constitute a judgement as of the date of publication and are subject to change without notice. Furthermore, no responsibility is accepted for the accuracy of any information contained within sites provided by third parties that may have links to or from our pages.

Rathbone Investment Management Limited ("RIM") is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered Office: Port of Liverpool Building, Pier Head, Liverpool L3 1NW. Registered in England No 01448919.

In accordance with regulations, all electronic communications and telephone calls between Rathbones and its clients are recorded and stored for a minimum period of six months.

The information provided in this site is directed at UK investors only. It does not constitute an offer to sell, or solicit an offer to purchase any investments by anyone in any jurisdiction in which such offer or solicitation is not authorised or in which a member of the Rathbone Group is not authorised to do so.

In particular, the information herein is not for distribution and does not constitute an offer to sell or the solicitation of any offer to buy any securities in France and the United States of America to or for the benefit of United States persons (being resident in the United States of America or partnerships or corporations organised under the laws of the United States of America or any state, territory or possession thereof).

In order to comply with money laundering and other regulations, additional documentation for identification purposes may be required.

Rathbones shall have no liability for any data transmission errors such as data loss, damage or alteration of any kind including, but not limited to, any direct, indirect or consequential damage arising out of the use of services provided or referred to in this website.

Past performance should not be seen as an indication of future performance.

The value of investments and the income from them can fall as well as rise and you may not get back the amount originally invested, particularly if your client does not continue with the investment over the longer term.

Changes in the rate of exchange between currencies may cause the value of an investment to go up or down.

Interest rate fluctuations are likely to affect the capital value of investments within bond funds. When long term interest rates rise the capital value of units is likely to fall and vice versa. The effect will be more apparent on funds that invest significantly in long dated securities. The value of capital and income will fluctuate as interest rates and credit ratings of the issuing companies change.

Tax levels and reliefs are those currently applicable and may change and the value of any tax advantage will depend on individual circumstances.

Investing in emerging markets or small companies may be potentially volatile, as these investments are high risk.

The design, text and images are owned, except as expressly stated by members of the Rathbone Group. They may not be copied, transmitted, displayed, performed, distributed, licensed, altered, framed, stored or otherwise used in whole or in part or in any manner without the written consent of Rathbones except to the extent permitted and under the procedures specified in the copyright Designs and Patents Act 1988, as amended and then only with notices of Rathbones' rights.

Rate this page:
No votes yet