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Fixed On Bonds

Sun, Sand and Summer Liquidity

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So it’s that time of the year, a great opportunity to reflect, relax and rejuvenate as the summer months bring a sense of calm to the markets and we all go on holiday to recharge…err…who am I kidding! As we all know, this is no typical year and no typical summer and as active investors we need to continue to be on our ‘investment toes’ as well as on the beach.

Since my last Great Debate on Liquidity, we have seen England cautiously ‘celebrate’ freedom day, global inflation data continue to spike to the upside, an increase in the Delta variant causing global growth to be questioned and the biggest news of all…England nearly brought it home! So in part 1, we discussed how a large percentage of bonds hardly trade with bonds ‘locked’ away. Now we need to discuss which bonds are more likely to trade with a focus on the date of issuance as a significant factor.  Even more than ever, it’s still important to talk about the liquidity of bonds in your portfolio as we do hit a summer grind, especially in the calm before the storm of corporate new issues in September.

The spirit of youth

Bonds come in all shapes and sizes with numerous characteristics but with all things being equal what is clear is that ‘younger’ bonds (those closer to the issuance date) will be more liquid than those that are more aged. Obviously factors such as size of issue, currency, maturity, seniority and ratings will all have an impact as well but understanding the age profile of your bonds can increase the liquidity of your portfolio.

The table below demonstrates how the daily average volume on US investment grade bonds dramatically decreases after initially being issued. By day 45, the average daily volume has dropped to 20% of the volume traded on the original day of trading. What may seem a small factor in assessing liquidity may actually have a large impact on your ability to trade in the market. In fact, MarketAxess have analysed that the bid offer spread increases over this time which is a sign of declining liquidity. This relationship can have a major impact in terms of the performance of your portfolio.

Source: MarketAxess January 2020 – March 2021

As active investors, we believe in keeping our portfolios nimble and agile and where possible taking advantage of the discount to fair value of new issues and using the liquidity of younger bonds to enhance performance. However, it should be noted that a credit bond portfolio will always consist of a range of bonds which are close to and far from the issuance date as each bond is picked on its own fundamental merits. Older bonds can in fact show more price stability in times of stress and provide a good anchor for the portfolio. Although it’s important to be mindful there could be a limited number of buyers and sellers when needed and so a delicate balance of both is required to enhance the liquidity of a portfolio.

As a credit dealer, if you are unable to source your required inventory, being able to replace bonds with liquid alternatives is key. Having an understanding of a bond’s characteristics such as age since issuance in combination with other factors is vital when assessing how it trades in the market and giving an informed view to portfolio managers. The increase in the use of platforms and technology in providing available and substitute inventory data can also significantly help this process as well as your own market experience. There is no doubt trading volumes have decreased as we move into the peak of summer which is normal for this time of the year. However, with Covid headline risk causing volatility and the new issues deluge on the horizon, heading into the paddling pool with a glass in hand won’t be the only liquidity assessment that needs to be carried out.

Risks

The value of stock market investments will fluctuate and investors may not get back the original amount invested.

Forecasts are not reliable indicators of future returns.

Government and corporate bonds generally offer a fixed level of interest to investors, so their value can be affected by changes in interest rates. When central bank interest rates fall, investors may be prepared to pay more for bonds and bond prices tend to rise. If interest rates rise, bonds may be less valuable to investors and their prices can fall.

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For Investment Professionals only. Not for onward distribution. No other persons should rely on any information contained within this document.

Whilst every effort has been made to ensure the accuracy of the information contained within this document, we regret that we cannot accept responsibility for any omissions or errors. The information given and opinions expressed are subject to change and should not be interpreted as investment advice. Reference to any particular stock does not constitute a recommendation to buy or sell the stock.

All data is sourced to Premier Miton unless otherwise stated. Persons who do not have professional experience in matters relating to investments should not rely on the content of this document.

Issued by Premier Miton Investors. Premier Portfolio Managers Limited is registered in England no. 01235867. Premier Fund Managers Limited is registered in England no. 02274227.  Both companies are authorised and regulated by the Financial Conduct Authority and are members of the ‘Premier Miton Investors’ marketing group and subsidiaries of Premier Miton Group plc (registered in England no. 06306664). Registered office: Eastgate Court, High Street, Guildford, Surrey GU1 3DE.

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