Lack of liquidity can have measurable impact on bond holdings GlobeInvestor
Some investors who are willing to take on low-grade bonds or those of troubled companies may seek to take advantage of illiquidity. That’s because existing holders of illiquid bonds of a company in crisis may be so desperate to get a bid that they accept a hefty price cut.Fresh corporate bonds have flooded the market in recent months as companies have taken advantage of low interest rates to load up their balance sheets with cheap debt.
One reason for a bond’s illiquidity is unfamiliarity with the issuer. Another is more technical, as each issue of a corporation’s bonds may differ in ranking or seniority. Some bonds need to be sold at a hefty discount of dozens of basis points – if they trade at all. These seldom-traded illiquid bonds can have gaps of $10 on a bond previously quoted at $100. That’s a 10-per-cent difference, and when bonds have low single-digit coupons, such spreads can turn a profit into a loss.
Unlike stock trading, in which dealers just get a commission, dealers trade bonds as principals and they care a great deal about getting a high price when they sell and paying little when they buy. Moreover, they don’t want to get stuck with bonds that their usual customers – including bond mutual funds, ETFs and institutions such as university endowments and insurance companies – don’t want.
For example, during the financial crisis in the autumn of 2008, most investors wanted to reduce leverage and sell almost everything except for short-term government bonds, which are essentially cash. Some days, there were no bids, recalls Vivek Verma, portfolio manager at corporate bond specialty investment firm Canso Investment Counsel Ltd., in Richmond Hill, Ont. “Spreads widen as bond quality goes down or the market gets illiquid.
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