Declining liquidity in Australian corporate credit markets is continuing, according to a key finding in Zenith‟s 2016 Australian Fixed Income (AFI) Sector Review.
Andrew Yap, Zenith Head of Multi Assets and Income Research, said “While this trend formed in the aftermath of the Global Financial Crisis (GFC), Zenith has observed an acceleration over the last 12 to 18 months. The reduction is due to a range of supply/demand, structural and regulatory factors. In response, the AFI universe has continued to evolve, with managers developing innovative methods to populate their respective exposure to credit”.
Regulatory influence is the largest contributor to the decline in liquidity, according to Zenith’s report. Under Basel III regulation, investment banks now have a lower propensity to warehouse bonds due to changes in capital requirements and general shareholder preference to minimise risky behaviour. Dealers are no longer the natural holders of bonds, instead perform an „agency‟ role of trying to match buyers and sellers.
To illustrate this, from 2007 to 2014, the inventories of bonds held by the banks declined from $212 billion to $60 billion. Over the same period, total debt outstanding reached all-time highs, which has resulted in bonds being held by natural or long-term holders, as opposed to trading-orientated investment banks.
Zenith‟s 2016 AFI Sector Review marked the second consecutive year where active managers were challenged in producing excess returns.
In a rare occurrence, both the median manager and first quartile manager marginally underperformed the benchmark (on a net of fees basis).
These outcomes were produced amidst an ever challenging macro-economic and legislative backdrop which saw the Bloomberg AusBond Composite Index (0+ years) return 3.38% for the 12 months ending 30 April 2016.
In the report Zenith also explores the rationale for the re-emergence of Cash Enhanced strategies in the post GFC era.
In a market where cash rates are at historical lows and have the potential to test a zero setting the zero bound, Zenith believes this trend may become more pronounced owing to the relative attractiveness of the space (by way of spread pickup to cash), and challenges of replicating benchmark returns.
Summary of the Zenith 2016 Australian Fixed Interest Sector Review:
From an initial universe of 94 products:
. 4 were rated “Highly Recommended” 24 were rated “Recommended”
. 9 were rated “Approved”
. 2 were placed on “Redeem”
. 55 were “Not rated”
