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Month: November 2014

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

Creditworthy or Not

Creditworthy or Not

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Here’s an analysis of how some corporate accounting shenanigans are playing out in credit markets, where aggressive earnings adjustments known as “add-backs” can make companies appear more creditworthy than their historical cash generation might otherwise indicate. The effect can be pretty darn substantial.

In the competitive world of online dating, men and women will embellish their profiles to attract the best mates. Salaries are engorged, ages are diminished and heights increased as singles seek promising partners.

In credit markets a similar trend is playing out as companies flatter their bottom lines to attract the best financing deals from investors who are willing to play along in order to get a shot at a debt product with juicy yields.

And here’s the key quote:

“Beauty – or the lack of beauty – is in the eye of the beholder,” says Scott McAdam, portfolio specialist at DDJ Capital Management. “In the late stages of a credit cycle where capital is cheap and there’s a lot of money chasing deals, companies will kind of get away with this.”

Credit markets play a risky dating game

Chasing our tails

Chasing our tails

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Or, the time I talked to a Belgian former call center worker who turned herself into an actual currency trading guru.

This story is about “social trading,’  which ranges from run-of-the-mill sentiment on Twitter to ‘copy-trading’ strategies that see individual investors following ‘gurus’ on eToro or imitating the investment strategies of hedge funds.

“Twitter is great. I like it almost as much as I like Dell,” Carl Icahn, the activist investor, exclaimed when he made his debut on the social media platform last year. He now counts 190,000 followers who hang on his every tweet.

In finance, as in life, imitation is often the sincerest form of flattery and the arrival of new technology combined with the proliferation of social media platforms and online networks makes it easier than ever for investors to share – and copy – trading ideas.

For its supporters this “social trading” is democratising the world of investing by reducing the traditional disparity in trading resources between large and small investors. For critics, this increasing accessibility opens up huge risks for uninformed traders, emboldened to bet big without performing their own due diligence …

Another question that could be asked is what effect the rise of ‘Simon Says’ (from passive investing to seemingly innocuous Twitter trend-following) has on markets? Do the investors who are able to get ahead of – and then generate the most — inflows, stand to outperform? And what impact does that have on markets in general? To the extent that markets were ever concerned with fundamental value, is that dynamic increasingly off-the-table? Do markets and investors become giant inflow-seeking missiles? Hmmm.

From Icahn to ‘I can’ social trading takes off

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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