Bond inventories held by dealer-banks have halved since 2007 blah blah blah.

What gets far less attention than bank balance sheets in the bond market liquidity puzzle is the other side of the equation, and that is the astounding growth of bond funds.

This column, based on a big BIS paper, has some big numbers to go along with it.

The BIS estimates that the bond holdings of the 20 biggest asset managers have jumped by $4tn in the four years immediately following the crisis. By 2012 the top 20 managers held more than 60 per cent of the assets under management of the 300 biggest bayside firms in 2012, up from 50 per cent in 2002.

In other words, while asset managers are increasingly concentrated in bonds, the asset management industry, in turn, appears to be increasingly dominated by a select group of elite managers.

… The issue of decreasing levels of liquidity in the bond market was recently highlighted by the Bank for International Settlements, better known as the central bank’s bank, which last week released a 57-page paper with the rather dry title of “Market-making and proprietary trading: industry trends, drivers and policy implications”.

Yet the dearth of traditional market makers is only one half of the liquidity story.
The other is the astounding growth of big bond funds, which in recent years have ridden a wave of low interest rates and a period of huge debt issuance by governments and companies to grow their balance sheets by staggering amounts.

Many of these funds have been herded into similar investment positions thanks to the increasing use of benchmarking, as well as ultra low interest rates, which have essentially encouraged them to “go long” on credit. Moreover, in an environment of one-sided demand for bonds, few fund managers have had to pay for their liquidity in recent years.

…

Liquidity puzzle lurks within bond funds’ extraordinary rise