If investors needed reminding how hard it is to trade bonds these days, the global debt sell-off sparked by Donald Trump's US election win has provided a timely reminder.
Indeed, institutional investors in the Asia-Pacific region believe lower market liquidity is a secular shift necessitating a new investment approach, finds a research report that was written and sponsored by the Alternative Investment Management Association (Aima) and State Street. The report covered 150 institutional asset owners and 150 asset managers.
Moreover, executives from Goldman Sachs Asset Management and JP Morgan confirmed that asset owners needed to adapt to the new environment – and in many cases are doing so.
Around 90% of Asia-Pacific respondents to the Aima survey said market liquidity conditions had affected their investment strategy, with 36% rating the impact as significant and saying they would re-assess how they manage risk in their investment portfolios.
More broadly, institutions are adjusting to a new environment in which trading roles have been transformed, new market entrants are emerging and electronic platforms and peer-to-peer lending are changing the way asset managers transact their business.
Almost 40% of participants in the survey planned to make changes to their investment policies in light of the evolving regulatory landscape.
A wave of new regulation following the 2008 financial crisis – including the 2010 Dodd-Frank Act in the US, the 2013 Capital Requirements Directive in Europe and the Basel III capital adequacy requirements – has constrained the ability of many US and European banks to act as market-makers. This has affected liquidity, notably in bond markets.
Basel III is a central element of the changes. While it will not be fully implemented until 2019, in January 2014 European and US banks started to report under the new rules, and many large firms are choosing to follow them sooner than required.
Many institutional investors have responded by reviewing their fixed income dealers, according to Greenwich Associates research published late last year. Some are simply trading less.
Meanwhile, investors across the board have renewed their focus on liquidity management, say industry observers.
Jason Granet, London-based head of international global liquidity portfolio management at Goldman Sachs Asset Management, explained the seriousness of the issue of liquidity risk for asset owners, particularly those with short-term obligations or liabilities.
“Generally speaking, the price of liquidity has changed, and we recognise that dealer and bank balance sheets might not be able to [carry out] large risk transfers at a specific moment in time,” he noted.
“Still, we don’t feel that liquidity conditions have changed meaningfully in the last year or so,” he added.
Granet said that recent events such as the US money market fund reform, Britain’s vote to leave the EU on June 23 and Donald Trump’s shock win in the US election on November 8 had sent ripples through the markets, and yet they were comfortably able to absorb these events. “This shows that investment practices are adapting to the new market reality.”
He suggested that asset owners were generally aware of changes in banks’ funding and cross-currency costs and the opportunities resulting from those dislocations. “In particular, we are seeing an increase in interest in money market funds, as clients look for daily liquid options in addition to bank deposits.”
The biggest disparity around allocations in the Aima survey was that one-third of institutional investors planned to raise their exposure to high-yield bonds in the coming year, while around the same proportion of asset managers planned to cut theirs (see graph below).
Asian investors have participated more actively in foreign bond markets in the past few years, due to relatively limited opportunities locally. Granet reckoned they would continue to look to global markets for opportunities, given the divergence in rates between the US and the rest of the developed world.
Cheah Kheng Leong, Asia-Pacific head of global liquidity sales, told AsianInvestor: “Liquidity investors [those in need of short-term liquidity] need to understand how banks will treat deposits under the new rules globally."
That would allow them to structure and segment their liquidity portfolios to gain the greatest benefit from the new rules and incentives, noted Cheah. “Properly segmenting cash balances into operating and non-operating pools and making investments that maximise returns on both pools has never been more important.” ('Non-operating' refers to a cash pool that is not invested.)
Eric Mogelof, head of Asia Pacific at US fixed income specialist Pimco, agreed: “The changing regulatory environment and resulting impact on markets has increased the importance of thoughtful liquidity management.”