From FT Alphaville:
All your futures may belong to long-term value investors
When it comes to bond market liquidity paranoia, it’s not the dealers we should be worried about but long-term value investors.
So at least says Bloomberg’s Matt Levine in his daily round-robin of what’s going on in the market:
The risk, if there is one, has to be located in what I’ve loosely called the value investors — the people who provide the ultimate bid for assets. Here there are obvious reasons for worry, which frankly I do not understand well enough to have any clear views. But the biggest worries revolve around the possibility of herding among bond investors and around those investors’ funding models. The worry is that there is one dominant model of bond investing, in which giant mutual funds and exchange-traded funds buy and hold every newly issued bond that comes along. Those funds offer their investors the ability to withdraw money pretty much any time they want. But if bond prices crash, investors will want to take their money out, the funds will need to sell, and all those giant bond funds that provided the bid for bonds on the way up will turn into sellers on the way down.
So, the argument goes, bond mutuals and ETFs are acting more like banks than banks — and in this new paradigm, where banks have loads of permanent equity and unsecured debt, and funds have redemption “at any minute” liabilities they can’t necessarily meet, the risk sits on the buyside, not on the dealer/sell side at all.
But as Levine rightly identifies, it’s wider herding behaviour that’s really the problem. If a major investor mind-shift causes a rush for the exit, whether these investors are sitting concentrated in two or three mega bond funds or a multitude of smaller funds doesn’t really make a difference to the overall outcome. All assets will fall in value.
And when they do, it is buyers of last resort that can make a difference, not dealers. Which is problematic, of course, if there’s a shared consensus on the fundamental value of all these assets.
ETF risk
Here at FT Alphaville, we’ve spent a significant chunk of the post-crisis era obsessing about how ETFs were distorting market structure, whilst exploiting long-term value investors by turning them into predictable and managed flows that can be easily anticipated. Unsurprisingly, the ETF industry — and its extremely well funded marketing arms — didn’t take kindly to these assertions. (These products are cheap! They’re accessible! They empower investors! Mutual funds are evil!)...MORE
