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M&G’s Woolnough on corporate bond liquidity

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M&G fund manager Richard Woolnough says corporate bond liquidity is not quite as low as people may believe.

Woolnough says while dealer inventories have shrunk, daily volumes are on par with where they were in 2007, when markets were exceptionally liquid.

He says: “There is an indication from looking at primay dealer positions in corporates with maturities of more than a year that traders’ ability to take on risk has collapsed by roughly 80 per cent, and therefore corporate bond market liquidity must have collapsed significantly in tandem, due to the disappearance of this historic pool of capital to bid for securities.”

Woolnough says a far more relevant number is to look at is the actual historic trading volume in secondary corporate bonds, which gives a stronger indication of liquidity.

The fund manager says: “This shows that turnover has not collapsed 80 percent in the same way as dealer inventory, and in fact daily volumes are on a par with where they were in 2007

“Total secondary volumes have recovered to 2007 levels, which means they have become mroe efficient and turnover per unit of inventory has gone through the roof.”

He also says bank lending has been replaced by a “new, hopefully more stable process of borrowers being funded via the corporate bond market.”

Woolnough adds: “As bank lending is replaced by more permanent term bond lending, then term mismatch and credit risk in the banking system is reduced, and that term and credit risk is assumed by the bond investor.

“The bond investor not only gets paid for assuming this risk but also has to work out what liquidity premium they need to be paid on top of the term and credit risk they have taken on board with their corporate bond position.”

He concludes: “While daily volume of primary markets is at record levels, while secondary market liquidity has not grown in line with the size of the market place, but is not as low as a simple analysis of dealer inventory would imply.”

In July, it emerged that M&G was looking at ways to stem inflows into Richard Woolnough’s £6.3bn Corporate Bond and £5.1bn Strategic Corporate Bond funds.

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