The trend of blockbuster US corporate bond sales has, at least for now, a silver lining for investors.
For a $6.7tn investment grade market in which complaints about a lack of liquidity — the ability to buy and sell bonds without moving market prices too far — have become a common refrain, the final trading day of the first quarter last week was arresting.
More investment grade bonds exchanged hands on March 31 than on any day since the Financial Industry Regulatory Authority began tracking data in 2005. Nor is a single frenzied day’s trading the only evidence to emerge from a quarter to suggest the picture in a market that has ballooned in size since the financial crisis is far more complicated than one of vanishing liquidity.
Rather, trading is becoming more concentrated in a handful of new, mega-sized bonds. New debt sold by Apple, brewer Anheuser-Busch InBev and just eight other companies during the quarter accounted for almost a tenth of the trading in dollar-denominated investment grade bonds in March alone, according to an analysis of trades conducted by MarketAxess for the FT.
“Liquidity is located in a few of the mega deals and a lot of the turnover has been lumped in those extremely large deals,” says James Shepard, head of investment grade debt capital markets at Mizuho. “You will get a $500m to $750m transaction that doesn’t trade very much at all. For smaller sized deals, there might always be a bid just not always an offer.”
Even concentrated trading is likely to be welcomed in a market from which Wall Street banks have been retreating, as higher capital costs force them to scale back from their historic role of facilitating the buying and selling of bonds for investors.
But relying on the ability of a small number of companies to borrow on an epic sale — AB InBev drummed up record orders for its January sale of $46bn of bonds to help fund its takeover of SABMiller — carries its own risks should the companies run into any sort of trouble.
“We want to be cautious,” says Lorenzo Napolitano, a portfolio manager with JPMorgan Asset Management “If there is another flare up that causes markets to trade off, you will see exacerbated moves.”
The muscle exerted by a handful of large bonds during the quarter came against the backdrop of robust issuance for investment grade debt which rose to $364bn in the first three months of 2016, just behind 2015’s record start to a year, according to data from Dealogic.
And while trading volumes have been brisk in vast, high-profile new debt, investors say activity in thousands of other bonds is declining even as the sustained period of low interest rates helps fuel the size of the overall market.
“When we think of liquidity and the challenges we’re seeing, liquidity has migrated to large and topical names,” says Sherif Hamid, a portfolio manager with AllianceBernstein. “It has been hard to trade the [smaller] and not topical names.”
Over the past 12 months, for example, less than two-thirds of high-grade bonds were traded sufficiently to match the size of the issues themselves, according to Finra. After the financial crisis, trading often took place at a frenzied enough pace that nearly 100 per cent of outstanding investment grade debt turned over in a year.
And investors say it is the reluctance of some Wall Street banks to shoulder the burden of creating liquidity that is sharpening the appeal of large issues among corporate fund managers who were accustomed to being able to trade in and out of smaller issues.
“The buy side has gotten so big relative to the dealer community that they need new issuance to add meaningful exposure as flows come in,” Mr Napolitano said. “Dealers don’t have the balance sheet capacity that they once had and as a result our reliance on the primary market has been growing.”
As ever, first quarter trading volumes were also shaped by the broader economic backdrop and appetite for risk, which rebounded after a torrid first six weeks of the year. High grade US debt returned nearly 4 per cent in the first three months, according to Barclays Indices.
Although investors jumped back in, they did so with more relish in the quarter’s biggest issues.
The volume of trades in a $2bn bond sold by Apple as part of a $12bn February financing package, for example, approached $3.1bn by the end of the quarter. If that pace were to continue for a full year, the bond would turn over more than six times.
“There’s less trading activity relative to the overall market size,” says Jon Duensing, deputy chief investment officer of Amundi Smith Breeden. “[Liquidity] certainly has become more focused in the larger issuers.”
That is happy news for the biggest borrowers, but brings its own risks.
