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Why does everyone want corporate bonds? One word: Alpha.

Why does everyone want corporate bonds? One word: Alpha.

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Why the intense scrum for new-issue corporate bonds? It’s not just the yield on offer from buying the new debt. It’s the fact that that yield, for a brief but important moment in time, exceeds the benchmark.

Here’s a little Bloomberg post based on research from Citigroup credit strategist Jason Shoup.

He estimates that investors can add 20 basis points of alpha just by purchasing new-issue bonds.

… Alpha has been scarce in recent years. More than half a decade of ultra-low interest rates and extraordinary monetary stimulus from the world’s central banks means that many assets are moving in tandem, making it more difficult for investment managers to find alpha-generating opportunities. If assets were racing they’d be neck and neck, so to speak.

However, one place where alpha can be generated is in the corporate bond market where big companies sell their debt. The reason is simple. When companies sell a new bond there is typically a lag between the bond being issued and when it’s included in benchmark fixed income indexes …

The simple reason why everyone wants new corporate bonds

One last (FT) look at the corporate bond market

One last (FT) look at the corporate bond market

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This is my last big story for the Financial Times, as I’m heading off to a brand new gig at Bloomberg. The piece seeks to bring together a lot of what I’ve written about bond market liquidity, the rampant search for yield and the growing power of big buyside investors into a single narrative. Do read the full thing if you can.

Dan McCrum at FT Alphaville also has an excellent summary.

I’ve left some key excerpts below:

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Creating liquidity from illiquid stuff

Creating liquidity from illiquid stuff

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A quick take on a long-running theme in markets, especially fixed-income.

Investors are reaching for a toolkit of exchange traded funds, mutual funds and credit derivatives to make up for a dearth of liquidity in parts of the financial system, according to market participants and research from Barclays.

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Many have turned to ETFs, mutual funds and certain derivatives to make up for a lack of liquidity. ETFs use a network of banks and trading firms to give investors cheap and instant exposure to a wide variety of assets.

The trend is particularly pronounced in the fixed income market, where new rules aimed at increasing bank capital and reducing the risk of a run in the “repo market” — Ground Zero for the financial crisis — are said to have most hurt ease of trading.

Risks squeezed out of banks pop up elsewhere

 

New column – Won’t somebody please think of the bond funds?

New column – Won’t somebody please think of the bond funds?

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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.

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Liquidity puzzle lurks within bond funds’ extraordinary rise

Did someone ask for more on bond market liquidity?

Did someone ask for more on bond market liquidity?

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Marketmakerliquidity

 

The Bank for International Settlements has released a 57-page paper on bond market liquidity, mostly examining the issue from the perspective of shrinking capacity on the dealer-bank side. It comes with the above schematic and plenty of other interesting facts and charts.

See also FT Alphaville, where my colleague Izabella Kaminska has started a liquidity series.

October 15. A financial markets whodunnit.

October 15. A financial markets whodunnit.

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On October 15, prices of US government bonds – one of the most liquid markets in the world – whipsawed violently and sparked a wave of speculation on Wall Street as to the culprit(s) behind the wild moves.

Here’s a longish analysis of what happened. The key suspects: lack of liquidity, the rise of electronic trading, a classic gamma trap (possibly sparked by the scuppering of the AbbVie/Shire deal) and much, much more.

… On October 15, the yield on the benchmark 10-year US government bond, which moves inversely to price, plunged 33 basis points to 1.86 per cent before rising to settle at 2.13 per cent. While that may not seem like much, analysts say the move was seven standard deviations away from its intraday norm – meaning it might be expected to occur once every 1.6bn years.

For several minutes, Wall Street stood still as traders watched their screens in disbelief. Electronic pricing machines, which now play a bigger role than ever in the trading of Treasuries, were halted and orders cancelled by nervous dealers as prices see-sawed.

The events have sparked a financial “whodunnit” as investors, traders and regulators seek to understand what happened – and to determine whether October 15 was a unique event or a harbinger of further perilous trading conditions to come.

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Bonds: Anatomy of a market meltdown

Reading list – Business adventures: 12 classic tales from the world of Wall Street

Reading list – Business adventures: 12 classic tales from the world of Wall Street

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So apparently everyone who is anyone has already read this book. Except me. It’s been sitting on my Kindle for months – untouched and unloved until very recently. But having started on this compendium of 1960s New Yorker articles just last week, I am now about a third of the way into it and all I can say is that this is the way business writing should be – full of fascinating and powerful narratives that tell you something about human behaviour as much as finance and markets and corporate intrigue. Oh, and the prose is to die for. You know, if that’s your thing.

Given recent events, one passage in the first chapter of the book struck me as particularly prescient.

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Synthetics, derivatives and leverage – oh my!

Synthetics, derivatives and leverage – oh my!

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Wall Street banks are encouraging the use of derivatives including total return swaps (TRS), credit index options (swaptions) and variants of the synthetic collateralised debt obligations (CDOs) that proved so disastrous during the previous financial crisis in an effort to serve investors the yield they so desperately crave.

(The crucial difference this time around, is that these are tied to corporate credit rather than residential home loans).

Read the following, and weep/laugh as you see fit.

Boom-era credit deals poised for comeback (December, 2013)

Last month Citigroup placed an unusual job advertisement. The bank was seeking an analyst able to crunch the numbers on an obscure financial security: synthetic collateralised debt obligations. Four weeks later, job applicants would find the position filled. Such has been the clamour among investors for the higher yields from higher-risk products that big banks including Citi, JPMorgan Chase and Morgan Stanley are turning again to the more esoteric parts of the financial markets.

Turning to total return swaps (July, 2014)

A type of derivative known as a “total return swap” has become a hot ticket item on Wall Street as investors seek out new ways of playing booming credit markets, while banks – including Goldman Sachs – find fresh methods to finance their assets.

Investors dine on fresh menu of credit derivatives (August, 2014)

The renewed boom in credit derivatives is being powered by yield-hungry investors and Wall Street banks looking for new revenues. The two instruments helping investors play booming corporate credit markets at this juncture include total return swaps (TRS) and options on indices comprised of credit default swaps.

The slow drip liquidity story – updated

The slow drip liquidity story – updated

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Updated: October 17, 2014 given recent market events and sudden interest in all things liquidity-related. To be clear, the lack of liquidity just exacerbates market moves. The underlying problem is that complacent investors have been in the same (long) positions for the past five years, selling volatility and levering up to boost returns.

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A by-no-means-extensive list of my work on the changing structure of the bond market.

Goldman eyes electronic bond trading (March, 2012)

Finance: Grinding to a halt (June, 2012)

Dealer and investor talks over liquidity fears (June, 2012)

Goldman launches bond trading platform (June, 2012)

Bond trading model shows signs of stress (October, 2012)

Banks tout idea of sharing bond data (November, 2012)

Slow-drip bond sell-off masks a problem (November, 2012)

Markets on edge as investors seek exit (June, 2013)

ETFs under scrutiny in markets turbulence (June, 2013)

Markets: the debt penalty (September, 2013)

Digging into dealer inventories (September, 2013)

Verizon’s $49bn bond sale whets appetite for larger issues (September, 2013)

ETFs: Tipped as liquidity source (November, 2013)

Global liquidity: Buyers struggle to find a safe landing (November, 2013)

Big US banks back new bond trade venue (November, 2013)

Investors turn to ‘shadow’ bond market (January, 2014)

Banks are a proxy for credit bubble fears (March, 2014)

Taper tremors fail to deter ETF investors (May, 2014)

Checking out of the ETF hotel could be costly (May, 2014)

‘Patient capital’ ready to exploit bond market sell-off (June, 2014)

Fed looks at exit fees on bond funds (June, 2014)

Bonfire of the bond funds (June 2014)

BlackRock’s Aladdin: Genie not included (July 2014)

Investors in junk bonds face a Matrix moment (August 2014)

Finance: The FICC and the dead (August 2014)

Investors dine on fresh menu of credit derivatives (August 2014)

Yield-hungry markets overlook credit risk (September 2014)

US corporate bond traders go electronic (September 2014)

Gross exit from Pimco tests bond market (September 2014)

Wall St sheds light on Bill Gross reign after Pimco departure (September 2014)

At the risk of sounding like a broken record, expect more on this.

HFT – dazed and confused

HFT – dazed and confused

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Dazed and Confused’s famous “School’s out” scene starts with a warning from a rather candid teacher: “This summer when you’re being inundated by all the American bicentennial fourth of July brouhaha. Don’t forget what you’re celebrating and that’s the fact that a bunch of slave owning aristocratic white males didn’t want to pay their taxes.”

It came to mind as I was reading Scott Locklin’s review of the new Michael Lewis book. I’m a big Lewis fan (a highlight of my career was being CCed in on an email to Lewis, which perhaps says something non-flattering about my career), but amidst this week’s “brouhaha” over Flash Boys, I think Scott makes some very interesting points.

I know a few HFT type people. One of ‘em might be even be as rich as Michael Lewis.  So far, all the ones I have met are clever and decent people, and I figure whatever they’ve managed to earn by the sweat of their brows, they deserve it. I’m not real pleased with the idea of a small group of decently paid, politically helpless nerds being the fall guys for a bunch of crooked oligarchs who don’t want to pay for their liquidity.

Michael Lewis: Shilling for the buyside