Seeking Clarity In Bonds

With Trevor Leydon, Head of Investment Risk and Portfolio Construction, AVIVA Investors
Bond trading issues
We wouldn’t say there are problems with bond trading at present, rather there are things that we are acutely aware of, particularly as we are in summer and that is historically a period of lower liquidity. Many seasoned hands are discussing the risks around the hunt for yield pushing less cautious investors into spaces where greater or different risks can lie unseen unless you have suitable expertise or insight. The shrinking of yields to the current levels, the re-emergence of covenant ‘lite’ and the wall of less sticky money entering some areas of the bond market over the last few years are all examples of things which are featuring more prominently in people’s minds.
If corrections were to occur this could be a harsh lesson for some investors who are less well prepared. These challenges mean that the value of an asset manager like Aviva Investors to an underlying investor is even greater because we can have the capacity and capabilities to construct an investment portfolio which delivers against the outcomes that the clients talk to us about, be it income, capital growth or protection against inflation.
On the trading front the summer period in more recent years has seen the issue around lower capacity of market players to provide liquidity through warehousing inventory being exacerbated.
This combination of the absence of market participants and the consequences of various stakeholders altering the ability of the sell side to act as intermediaries adds risks to the system and could have unintended consequences. The traditional role of intermediaries along with other participants was and still is very important, as they could, at times, have acted as a mechanism to avoid markets gapping down.
We don’t believe that there are problems that are unique to the electronic markets, rather the migration from the phone based market to electronic platforms will take time: markets where there are less market participants, such as some emerging ones, these will not move as quickly as some of the developed markets such as G7 Gov’t bonds. This is because until there is enough liquidity in those markets participants are not comfortable showing their hand to the wider market. As these concerns fade through increased participation this will be less of an obstacle to markets going mainly electronic.
Regulation, market structure solutions, and new technology
There is always a balance between regulation and allowing the markets to provide solutions. That is a balancing act that can be incredibly difficult to achieve as rules that are designed with the best of intentions can have completely unintended consequences in the real world on investors. Likewise market provided solutions can take time where there are competing goals and objectives. Finding that optimal level of regulation in a market that evolves as quickly as the global electronic financial markets requires international co-operation between regulators and also the participants.
Technology can be transformational, it can lead to new and exciting developments but as we have seen with some electronic trading developments over recent years it is not without risk. In the reputational sphere, firms need to understand the changes, the challenges, the risks and also, the returns from these developments.
Transparency in trading and inventories?
The measuring of liquidity is proving to be a major challenge within the industry in general and amongst bond managers in particular. Recent regulatory changes such as attempting to quantify liquidity profiles of funds for investors is something that we strongly support. However we appreciate that it requires assumptions in modelling and ultimately using an element of professional judgment to supplement somewhat limited information. Anything which can assist the industry in this space is going to receive a lot of attention and support, pooling of anonymised information in terms of liquidity would allow investors greater transparency around whether they are being correctly compensated for liquidity or more importantly the lack of it. At Aviva Investors we are fortunate to have an array of expertise and talent which has devoted considerable efforts to developing measurement techniques in this area however, we still recognise that it is an areas where collectively as an industry we should seek to do more.