MarketSaga

Saga of Financial Markets

Mon10232017

Last updateSat, 29 Jul 2017 12am

Back You are here: Home Blog Blog Update Opinion Is High Yield Bond Liquid?

Is High Yield Bond Liquid?

Since 2007-2009 financial crisis, the trading environment for fixed income credit has changed.  We have been told that the regulation change such as the introduction of the Basel III and etc had made the bond trading, in particularly high yield bond illiquid and as a result trading cost high?  Is that true?

 The chart below illustrates that the liquidity in credit markets has fallen.

Accordingly, the bonds being held by bank dealers has collapsed, but the size of high yield market has grown substantially over the same period as shown below:

With the bigger size, the amount of investor capital being directed into high yield has increased.  To some extend, this marginal capital has replaced the lost bank liquidity.  Further, from the above, we observed that the global high-yield market turnover is below where it was a decade ago, it has actually recovered since 2011.  With the inclusion of the institutional only 144A bonds that make up approximately 30% of the market, average $10.7bn per day in 2015, up from $8.5bn per day in 2014.

The chart illustrates the trading cost for different grades of high yield bonds:

As for the "round-trip" liquidity cost - instantaneously buying and then selling the same security, has become more expensive for most of the high yield universe, in particularly the CCC-rated bonds.

In summary, we may conclude the change in regulation does not impact much on higher graded high yield bonds, however, it appears that it does have an impact on the lower rated, in particular CCC-rated bonds.  We may not need to worry about the liquidity for better grade high yield, but we do need to watch out for the contagious risks when the FEAR kicks-in to lower rated high yield default.

Reference:

Neuberger Breman | Insights, Patrick, Flynn, 2016-05-10, "High Yield Liquidity:  High and Dry?"