On our last Bramshill Investments quarterly conference call, a couple of our investors asked the following questions:
Q1: Are there any liquidity concerns across fixed income today given that dealer inventories are so much lower than they used to be?
A: Art DeGaetano – The past three years, issuance in the US corporate bond market has doubled in size. The liquidity around the street has been taken down by about 50%. So just on those two factors alone, there is not a great technical set-up. The market has also seen firms like MarketAxess and TruMid, which are electronic trading platforms, significantly take market share in the corporate bond market in everything from distressed to high yield up to investment grade corporates, even though distressed hasn’t been that active given the recent set-up. Liquidity is for sure a big part of our investment analysis and we think that the next downturn will probably be similar to the taper tantrum. I think we are personally better positioned for it because we have many fixed to floats and structures that will have a tough time going down too far even in a credit widening environment (unless you got to an 2008 credit environment). So, yes liquidity potentially a bigger issue than it’s been in the last ten years simply because the street capital commitment is so much lower and if there were to be price gaps, which we haven’t seen in a long time, I think they would happen quicker and would be deeper than the moves than we’ve seen recently.
Q2: Are there any liquidity concerns across fixed income today given that dealer inventories are so much lower than they used to be?
A: Derek Pines - This is a year where most of fixed income strategies have returned negatively, as we mentioned. It’s mainly been due to rates, with the exception of investment grade corporates, which widened a little bit on spread but most of that widening was more of a technical. Investment grade corporates were the biggest under-performer this year in US fixed income due to massive issuance, especially in M&A. However, for the most part, credit markets have been holding up pretty well. Issuance continues to set record numbers almost every year and people just absorb it. They buy it all whether its ETFs eventually buying it, or funds. But people are absorbing it. The biggest pitfall coming is that illiquidity and when everyone starts to exit at the same time. When everyone starts going the other way, the exit door has just gotten so much smaller because the liquidity is gone. That’s our biggest fear and that’s why we want to be positioned defensively the way that we are today. You can certainly see that happen at times as we mentioned earlier in BBBs and long duration instruments. I think something else we mentioned on our Webinar is high yield. We see a very levered buyer base. As rates rise they are also risking their borrowing costs. They used to buy 6% high yield bonds and lever them at basically zero borrowing costs. Now they are trying to lever those bonds with 2 ½ - 3% borrowing rates. That risk reward just isn’t the same anymore. So when that exit occurs it’s just a matter of being on the other side of that. It’s will be a massive move of people trying to get out of a very small exit door. Opportunity wise that’s why we’re positioned the way that we are. Being defensive and awaiting some of these dislocations.
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