(Corrects third to last paragraph; MarketAxess did not buy the
Aladdin platform from BlackRock but entered into a partnership)
* Regulators scrutinise impact of poor bond liquidity
* Calls for enhanced risk disclosures for mutual funds
* Buyside adapt to waning bank risk appetite
By Christopher Whittall
LONDON, March 10 (IFR) - Asset managers are revolutionising
their approach to bond trading to counter growing fears over
their ability to keep pace with redemptions in the event of a
sudden pullback from fixed income. The move comes as regulators
are scrutinising the precarious liquidity mismatch of mutual
funds invested in increasingly illiquid corporate bond markets
while offering investors daily liquidity.
Liquidity has drained from secondary credit markets in
lock-step with dealer bond inventories cratering from a peak of
US$235bn in 2007 to a mere US$37bn now. Over this time, mutual
funds - most of which offer daily liquidity to investors - have
mushroomed to US$840bn, according to Citigroup, on the back of a
glut of global debt issuance.
Bond fund supremos are loath to admit that fixed-income
funds should no longer provide daily liquidity for fear of the
asset class losing its lustre in the eyes of investors, and many
are adapting their operations in an attempt to preserve the
But the inability of capital-constrained dealers to buffer
the flows once the sun sets on the 30-year fixed-income bull
market has raised the grim prospect of asset managers resorting
to gating supposedly open-end bond funds during bouts of extreme
"It never was appropriate for corporate bond funds to offer
daily liquidity, and it's now more inappropriate than ever given
the size of mutual funds and the inability of the Street to
warehouse risk," said Matt King, head of credit strategy at
"We are in favour of efforts to improve liquidity, but it's
doubtful they'll make much of a difference. Bonds are not
equities - they really need a warehouse."
RISING TO THE CHALLENGE?
Questions remain over what would happen if fund redemptions
outpaced managers' ability to liquidate bond holdings and return
cash to investors. Global regulators including the Bank of
England, the US Treasury and the Federal Reserve are all
understood to be monitoring the issue.
One credit market veteran said that if the liquidity wasn't
there, an open-end fund would become a closed-end fund. "It
would be unpleasant and unfortunate, but it's the harsh reality
of life," he said.
Policymakers may yet insist on greater disclosure of fund
liquidity risk rather than relying on investors to read the
small print. For their part, asset managers are adapting behind
the scenes to the new trading environment.
"Everyone is painfully aware of the liquidity challenge and
portfolio managers are modifying their strategies accordingly,"
said Richie Prager, global head of trading and liquidity
strategies at BlackRock.
Larger asset managers stand accused of leaning on syndicate
desks to secure meaty bond allocations to avoid having to buy
their fill in pricey secondary markets. Some now only buy bonds
they are comfortable holding to maturity, while others squirrel
away a disproportionate amount of cash to handle redemptions,
creating a natural drag on performance.
Many firms have also transformed trading desks to act as
internal market-makers between their own funds - one firm
estimated as much as a quarter of its bond flows were now
executed in this way - while others have established capital
markets groups to source assets directly.
"As clients demand daily liquidity, and within the context
of investment banks decreasing the availability of risk capital,
buyside trading is now an incredibly important aspect of
investment management. It has a far greater impact on fund
liquidity and performance than ever before," said Stephen Grady,
global head of trading at Legal and General Investment
TURNING TO CDS
Managers who had prided themselves on appearing
plain-vanilla in the aftermath of the financial crisis are now
finding themselves increasingly drawn to the liquid and
standardised credit default swap market to shift risk.
"If you're selling daily liquidity funds, you have a duty of
care to optimise the liquidity of those assets. That includes
looking at other ways of accessing liquidity such as using CDS,"
said Fraser Lundie, co-head of investment manager Hermes Credit.
While bond investors concede there is no single solution to
the industry's liquidity problems, there are a number of
initiatives that might help, such as buyside-to-buyside trading
platforms, adapting trading protocols and encouraging companies
to standardise debt issuance schedules.
Some of these efforts have foundered. Last year, MarketAxess
partnered up with BlackRock, taking over the electronic trading
and broker dealer operation for the asset manager's struggling
Aladdin bond trading platform, while Goldman Sachs recently
shuttered its G-Sessions offering. Practitioners say even
successful platforms will only help at the margin, and are
unlikely to be open for business during a genuine market
Meanwhile, the issuer's paradise created by lax monetary
policy means there is little economic incentive for companies to
standardise issuance programmes. There is, though, too much at
stake for asset managers to give up the fight, meaning something
will have to give eventually.
"Everyone's behaviour is changing, which will eventually
lead to a new market structure where liquidity is less of a
challenge. The evolution is not going to happen overnight, but
we're making progress on virtually every front," said Prager.
(Reporting By Christopher Whittall, editing by Matthew Davies)