Unreliable Market Liquidity Poses Challenges and Presents Opportunities for Investors, According to BNY Mellon Traders
Dec 4, 2012
Bonds More Affected than Equities
NEW YORK and LONDON, December 4, 2012 — The unreliable availability of market liquidity since the onset of the 2008 financial crisis has made investors' portfolios more vulnerable to periods of market stress, but it also has provided opportunities for those who can exploit pricing dislocations that could result, according to a white paper written by the heads of trading from three BNY Mellon Investment Management investment boutiques.
Changing business conditions and the effects of regulatory changes such as Basel III and the Volcker Rule have impaired over-the-counter dealer markets such as those that trade bonds, the traders said. In addition, the trading volume of stock markets now is dominated by high-frequency dealers, the report said. The report, The New Liquidity: Investment Implications of Structural Market Changes, noted that the high-frequency traders differ significantly from traditional dealers.
"While they deliver fast execution and tight spreads for small orders, they supply less stability and less reliability for highly demanding orders," said David Brooks, a co-author of the report and managing director of global equity trading at The Boston Company Asset Management, LLC, a BNY Mellon investment manager. "They also are less reliable and stable for all orders during periods of market stress."
The major source of dealer liquidity historically came from human specialists on traditional exchanges or from the trading desks of broker/dealers, the report said. The increased automation of exchanges decimated the ranks of the specialists on traditional exchanges, while reduced margins, general banking deleveraging, stricter capital requirements and a greater focus on core businesses have dramatically reduced the capabilities of the trading desks, the BNY Mellon traders said.
Credit markets have been affected more than the equity markets because the bond markets are more diffuse as corporations have many different bond issues, and some could go days or weeks without being traded, the report said.
"Investors need to be prepared for higher volatility because of growing liquidity constraints, especially in certain parts of the bond markets," said Lynn Challenger, a co-author of the report and managing director of trading at Mellon Capital Management Corporation, a BNY Mellon investment manager. "They should consider their liquidity needs in both benign and turbulent markets and how they will source it."
Another defensive move suggested by the traders is for investors to maintain tighter tolerance ranges around asset allocation targets so they have a smaller effect on the markets when they need to rebalance.
However, the fragmentation of liquidity also is likely to create transitory distortions in prices, providing opportunities for those with readily available capital and the ability to deploy it before the opportunity disappears, said Amy Koch, a co-author of the report and managing director of fixed income trading at Standish Mellon Asset Management Company, a BNY Mellon investment boutique.
BNY Mellon Investment Management is one of the world's leading investment management organizations and one of the top U.S. wealth managers, with $1.4 trillion in assets under management. It encompasses BNY Mellon's affiliated investment management firms, wealth management services and global distribution companies. More information can be found at www.bnymellon.com.
BNY Mellon is a global financial services company focused on helping clients manage and service their financial assets, operating in 36 countries and serving more than 100 markets. BNY Mellon is a leading provider of financial services for institutions, corporations and high-net-worth individuals, offering superior investment management and investment services through a worldwide client-focused team. It has $27.9 trillion in assets under custody and administration and $1.4 trillion in assets under management, services $11.6 trillion in outstanding debt and processes global payments averaging $1.4 trillion per day. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation (NYSE: BK). Additional information is available on www.bnymellon.com or follow us on Twitter@BNYMellon.
All information source BNY Mellon at September 30, 2012. This press release is qualified for issuance in the UK and US and is for information purposes only. It does not constitute an offer or solicitation of securities or investment services or an endorsement thereof in any jurisdiction or in any circumstance in which such offer or solicitation is unlawful or not authorized. This press release is issued by BNY Mellon Investment Management (US) and BNY Mellon Asset Management International Limited (ex-US) to members of the financial press and media and the information contained herein should not be construed as investment advice. Past performance is not a guide to future performance. The value of investments and the income from them is not guaranteed and can fall as well as rise due to stock market and currency movements. When you sell your investment you may get back less than you originally invested. Registered office of BNY Mellon Asset Management International Limited: BNY Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Registered in England no. 1118580. Authorized and regulated by the Financial Services Authority. A BNY Mellon Company