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Bond Traders Flock to ETFs, Venues and Technology to Manage Risk in Credit Markets

Traders Magazine Online News, December 26, 2018

Ivy Schmerken

With volatility spiking in global stock and bond markets, there’s been a profound shift in market psychology from chasing higher yields to focusing on risk in the credit markets, according to a recent webinar.

“Given the impact of rate hikes and supply in the markets and trade disputes, it’s really no surprise at all that clients have had some sensitivity in managing volatility,” commented Michael Noto, managing director, market structure, Barclays on the Greenwich Associates Dec. 11 webinar, “Liquidity in Credit Markets.”

Electronic bond trading platform Trumid has witnessed the shift in terms of a rotation out of riskier assets and into less risky assets, said Amar Kuchinad, chief strategy officer at Trumid.   “You can see the buy-to-sell ratio on IOIs [indications of interest] and on orders,” he said. “On days when there is a lot of market volatility, you can see there is a lot more buying interest in investment grade bonds and more selling interest on high yield,” said Kuchinad.

Over the past six months, the cost of a transaction has jumped by about 25% on average, said Kuchinad, based on transaction cost analysis (TCA) conducted by Trumid on the platform.  “It appears that people are willing to pay a little more to get the liquidity that allows them to manage their risk as they and their portfolio managers have decided they need to shift their portfolios,” he said.

Corporate Bond IPOs

In the past few years, a major source of liquidity in the corporate bond market has taken the form of new issues.

“2018 is the first year where the level of issuance is going to decline year over year,” said Ken Monahan, vice president of market structure at Greenwich, who moderated the discussion.   High-yield issuance is down 35.3 % and investment grade corporate bond issuance has dropped 14.8% versus 2017.

Trades reported across the marketplace tend to be concentrated in new issues, said Trumid’s Kuchinad. Twenty percent of all trades reported to TRACE this year were in bonds that were issued over the prior five days, he said.

One of the main catalysts for the reduction in supply of new issues is higher borrowing costs resulting from rate increases.  “There has been a lack of supply combined with pockets of volatility, and trade issues impacting a lot of industrial domestic issues have influenced the names [of corporate bonds] that investors buy,” said Noto.

While the participants are seeing increased bid-offer spreads and a lack of liquidity, this reflects more volatility in the market than it does the lower proportion of new issues this year, said Noto.

Despite the slump in sales of new bonds this year, Noto said that market analysts are not forecasting a decline in issuance for 2019.

ETFs Grow in Popularity

With concerns about liquidity in corporate bonds, investors are turning to exchange-traded funds, which track an index of the most liquid corporate bonds.

In a Greenwich survey of 60 respondents in 2018, 59% had plans to increase their usage of ETFs.

ETFs are viewed as a proxy for actual corporate bonds where liquidity has declined over the past ten years as new regulations have forced dealers to reduce their risk and inventories.

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