For all the concern that Wall Street’s shrinking balance sheets will
fuel a liquidity crisis when investors flee credit markets, Citigroup
Inc. strategist Stephen Antczak says investors may be overlooking an
even bigger catalyst.
The size of the U.S. corporate-bond market has ballooned by $3.7
trillion during the past decade, yet almost all of that growth is
concentrated in the hands of three types of buyers: mutual funds,
foreign investors and insurance companies, according to Citigroup. That
combination could lead to more selling than the market can absorb when
the Federal Reserve raises interest rates for the first time since 2006,
Antczak said.
“All
the money is going to the same place, and when something adversely
impacts one, chances are the same factor adversely impacts everyone
else, and there’s nobody there to take the other side,” Antczak said in a
telephone interview. “We used to have 23 types of investors in the
market. Now we have three. In my mind, that’s the key driver.”
The three investor groups hold almost two-thirds of total corporate
debt, Citigroup data show. Mutual funds, which are forced to sell when
investors redeem cash, grew the fastest, more than doubling their share
to 22 percent in 10 years. Overseas investors now hold almost a quarter
of the market. Wells Fargo & Co. analysts warned last month that those buyers may be prompted to exit if the dollar weakened at the same time bond yields rose.
Liquidity Warnings
Hedge funds, government pension funds and securities brokers are among 20 other groups that hold 37 percent.
Everyone
from Fed Chair Janet Yellen to JPMorgan Chase & Co.’s Jamie Dimon
have echoed warnings that evaporating liquidity in the bond market will
exaggerate a selloff when the central bank raises its benchmark interest
rate. Most of that concern has been focused on the bond holdings of
banks such as JPMorgan, Deutsche Bank AG, and Goldman Sachs Group Inc.
that act as market makers and can step in to buy when investors sell.
Dealer inventories of corporate bonds plunged more than 76 percent in
the years after the financial crisis as tougher banking regulations
made it more expensive for them to hold risky assets.
‘Known Unknown’
“The low levels of dealer balance sheets
suggest that dealers will not be willing to make purchases to offset the
selling flows,” Jim Caron, a money manager at Morgan Stanley Investment
Management, which oversees $406 billion, said in an e-mail. He called
liquidity a “known unknown risk” for bond markets.
Citigroup’s Antczak has been telling investors that instead of
focusing on the dealers, they need to diversify their positions by
buying less liquid assets that other investors won’t be rushing to sell
first when sentiment sours. That would help them weather volatility and
potentially become buyers while others are selling.
“A couple of investors have been acting like brokers, thinking about
being a source of liquidity to the Street,” Antczak said. “They are big
and able to hold less-liquid positions because they don’t have to mark
it against the market and can hold until maturity.”
Stepping In
That’s what New York Life Insurance Co.’s
investment arm, which oversees $215 billion of policyholder money, did
during the so-called taper tantrum of 2013. The Fed’s move to end its
unprecedented stimulus measures that year triggered a selloff that wiped
out 5 percent from U.S. speculative-grade corporate bonds in less than
two months.
The declines were “exaggerated because the need for liquidity was in
excess of what the dealer community could provide,” Tom Girard, head of
fixed-income investments at NYL Investors, said in a telephone
interview. The firm stepped in to buy both investment-grade and
speculative-grade securities, he said.
“New York Life acquired significant amounts of bonds at very
attractive spreads and yield levels because we were able to provide
liquidity,” he said. “If we get another situation similar to that taper
tantrum, then from my perspective it starts to shift from a challenge to
an opportunity.”
Companies have issued an unprecedented $9.3 trillion of bonds since
the start of 2009 as the Fed cut its target rate to almost zero and
borrowing costs plunged to record lows, data compiled by Bloomberg show.
Next Crisis
The world’s biggest money managers, including
Pacific Investment Management Co., BlackRock Inc. and Vanguard Group
Inc., have been discussing the issue as part of a Securities Industry
& Financial Markets Association group. Last month, they asked
the U.S. Securities and Exchange Commission to form an advisory
committee to focus on liquidity -- the ability to buy and sell easily
without greatly affecting the price of a security.
“The size of that corporate bond market, with the lack of liquidity
that currently exists today, is something that people on the buy side,
sell side and regulatory side need to be focused on,” James E. Staley, a
managing partner at the $21 billion investment firm BlueMountain
Capital Management, said last week at a conference in New York. “If
financial crises tend to happen every seven years, it’s about time we
start getting worried about possibly the next one.”
