With bonds exposed to market volatility, how can investors seize emerging opportunities in fixed income?
The current liquidation in the market is the result of the de-leveraging process, risk models that limit managers’ scope, tightening of bank lending, and rebalancing of balanced portfolios, said Marc-André Lewis, senior-vice-president, fixed income, with Natcan Investment Management, speaking in Toronto at Natcan’s Bond Markets: Risks and Opportunities seminar on Wednesday.
“The more liquidity deteriorates, the less and less assets are able to sell,” he said.
This ongoing liquidation leads to a reduction in leverage, and the only way to finance a stable pool of assets while reducing the leverage is through “massive recapitalization,” he continued. To do this, you have to separate credit risk from liquidity risk.
By focusing on the liquidity premium (found in corporate bonds and government—though not federal—bonds), an investor can liquidate a position without incurring a significant loss. Whereas, with credit risk, there’s the probability that the issuer can default or have its credit rating cut.
For the mid- to long-term investors who aren’t as vulnerable to daily market value variations, liquidity premium is an attractive option, Lewis said.
Even though credit spreads are currently at high levels, he said these investors should gradually increase their exposure to corporate bonds and government (excluding federal) and para-government bonds. Their spreads are very high, he said, and they only entail liquidity risks.
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