A conversation with Scott Mather, Mihir Worah, and Mark Kiesel.
Liquidity in certain sectors—especially the corporate bond sector—is lower than it used to be. But that isn’t always a problem. If you’re a long-term investor, then lower liquidity is often an opportunity to add alpha.
What’s behind lower bond market liquidity?
For the past several decades, bond market liquidity was increasing as Wall Street added to its market-making and buffering capacity. Today, however, the combination of post-crisis capital and liquidity regulations and a lower return environment has made banks less able and willing to function as market makers. So there are fewer market makers contributing less balance sheet to individual sectors of the bond markets.
What are the implications?
We at PIMCO don’t think this lower level of liquidity presents a systemic risk. We do not expect massive market dysfunction where markets have trouble clearing, for example, or something that resembles a financial crisis or forced deleveraging. What we are seeing is “jumpy” pricing, because real buyers have to be connected with real sellers and that can take a little bit more time.
Transactional liquidity
Another important point is that there is a lot of transactional liquidity in the market. We’ve had record issuance of corporates for instance—new issues of very large size getting placed without disturbing the market. And it’s been similar with Treasury supply: There’s a lot of transactional liquidity. So this aspect of liquidity remains positive.
Opportunity for alpha
While there is lower liquidity in certain bond sectors, especially the corporate bond sector, it’s not always a problem. If you’re a long-term investor, then lower liquidity is often an opportunity to add alpha because the market gets irrational and moves more than it should—both on the upside and on the downside. So when the market overreacts and sells off more than fundamentals warrant, PIMCO will buy those positions and vice versa the other way. We spend a lot of our time managing liquidity, figuring out whether we need to be more defensive or less defensive.
Video: Bond market liquidity
PIMCO’s Mather, Worah and Kiesel explain why bond market liquidity is lower, and why it’s not always a problem.
Learn more at pimco.com.
Scott Mather is CIO U.S. Core Strategies, Mark Kiesel is CIO Global Credit, Mihir Worah is CIO Real Return and Asset Allocation and David Fisher is a managing director and product manager with responsibility for the firm’s core fixed income strategies.
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