During this period, the regulator also uncovered:
- An increase in the amount of failed or rejected trades.
- An increase in the amount of time it takes to fill an order.
- A decline in dealer quote rates on electronic bond trading platforms.
- A slight widening of some quoted and effective bid-ask spreads.
This represents “a worrying situation” according to Oliver Stone, head of research and deputy portfolio manager at Fairstone Private Wealth, but says it was an important piece of research as the previous regulatory studies failed to address the issue of transactions that had not taken place.
Liquidity issues in client portfolios were brought to the fore in the middle of last year, and in severe fashion. Even before the proverbial dust had begun to settle after the UK voted to exit the EU, property fund investors sought exodus.
Run for the exit?
According to data from the Investment Association, total outflows from all sectors topped £3bn during June alone, with more than £1bn pouring out of the property funds.
In order to deter investors, and potentially burdened by the need to sell underlying assets, a number of large managers such as Aberdeen, Henderson and Standard Life, were forced to either apply large dilution levies or suspend trading completely.
In respect of dilution levies, investors were left with the choice to either remain in the fund or face a large exit penalty. In the case of Aberdeen, this was 17 per cent.
Given the devastating impact for investors, especially those failing to clearly understand the inherent risk of open-ended property fund liquidity, could the same drama spill into the bond market?
“It’s not out of the question that fixed income investors could run for the exit,“ says Mr Trindade, who adds: “The decline in the number of market makers over recent years means that if this happens, there could be a large drop in liquidity.”
This view is shared by Mr Stone, who says: “Should inflation and rates continue to rise, or a policy misstep be made, things could get ugly - especially given the huge proliferation of passive bond funds and ETFs populated largely by retail money that is ‘hotter’ than traditional institutional money.”
In other studies, a clear relationship between risk and liquidity should help to clear the smog. In September 2016, the CFA institute published its ‘Secondary Corporate Bond Market Liquidity Survey’, in order to shine a light on the situation with regards to global bonds.
Importantly, the trade body noted, the respondents observed decreasing liquidity of high-yielding and investment grade corporate bonds but no change to their government counterparts.
It also found that a key determinant change in bond market liquidity could focus on the number of market dealers and the scale and frequency of market dealing activity.
Tellingly, the survey respondents witnessed a dramatic change in this area, with 55 per cent seeing a ‘Moderate decrease and significant decrease’ in the number of corporate bond dealers. In stark contrast, only 19 per cent observed a ‘moderate increase and significant increase’ in this area.