The liquidity discussion is however focused on the secondary market of corporate securities as opposed to the new issue market where companies, through investment banks, sell securities to investors. As the name suggests, sec-ondary trading occurs post new issue. On the IG side, turnover, or the percentage of traded relative to total out-standing securities has been in the 65-70% range since 2008. 2009 saw a jump in turnover to 90%. HY turnover has fallen to 100% from 110% in 2010. While the absolute volume of bonds trading thus has increased, the ability and cost to transact has become more challenging. For both the IG and HY markets, achieving liquidity for securities that do not benefit from the attributes that are most in demand (including recent vintage, certain covenants and structural features, issue size, coupon, etc.) could result in bouts of illiquidity and increased trading expense.
The main problem lies in the liquidity provided by the large investment banks, however. These have long been corporate bond liquidity providers; allowing for both the purchase and sale of securities with relative ease, given their large balance sheets and access to cheap financing. The adoption of enhanced banking regulations – including Dodd-Frank, which is designed to protect the financial markets – has resulted in a significant increase in these firms’ cost of capital. This has substantially affected their market making activities. Dealer “inventories” have plummeted, reducing the ease at which transactions previously occurred. According to Deutsche Bank, IG and HY bond inventories are down by 80% since 2007, despite the meteoric growth of outstanding corporate bonds. Without the use of dealer’s balance sheets, buyers and sellers must utilize brokers and many new electronic platforms to find either a buyer or seller of a particular security.
Given this “new world” of fixed income trading, bond investors should expect to experience greater pricing volatili-ty, elevated expenses, extended execution periods and greater levels of frustration.
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