Pretty much any investment, from equities to a Wayne Gretzky rookie card or NFT possesses a level of liquidity we understand, and a marketplace for exchanging those items for cash. The liquidity landscape for investors with exposure to bonds is more limited and significantly more opaque. But if you ask Timothy Hicks, chief investment officer at Lysander Funds Limited, that’s not really a problem, because it allows those bonds to do what they were designed to — earn interest until maturity.
Hicks notes that investors often think of liquidity as the ability to easily convert their investments to cash at a price in line with their expectations in a transparent market. If you’re holding equities, you may not always get the price you want, but you can sell them for cash at a price that confirms the market’s current view of their value.
“Bonds offer no organized exchange like there is for stocks,” Hicks says. “There’s a small network of bond dealers who are watching the prices the others are offering, but you don’t normally offer to sell to all the dealers at once. You need to approach each one to see who is offering the best price. Sometimes bond market values are affected by market conditions, so if you want to sell that bond today, that’s its price.”
Even Canadian government bonds can face liquidity challenges as bond markets may not be willing to absorb a large number of bonds with specific characteristics at any given time. At the beginning of the COVID-19 pandemic in early 2020, investors attempted to liquidate bonds as well as stocks.
“For some of those bonds, there were no takers,” says Hicks. “Even under less unusual market conditions, you may be offering 10-year government bonds, but one dealer may already have lots of them, and they need to consider the market for reselling them. What they really want is more 30-year bonds, so maybe they’re discounting their offers a bit more aggressively and widening their bid-ask spread.”
Some investors turn to bond ETFs or bond funds — mutual funds invested entirely in bonds — in simultaneous pursuit of higher yields and liquidity.
“You may have greater liquidity, provided everyone isn’t selling at the same time,” says Hicks. “But often, the performance of these products is limited because the bonds represented in them are more heavily weighted in the most indebted companies. They’re not necessarily selected because the underlying companies are more likely to repay their debts, or because they offer the most favourable repayment terms.”
Lysander is an experienced Canadian investment fund manager that offers diversification through funds invested in corporate bonds, the portfolios of which are managed by Lysander’s affiliate, Canso Investment Counsel.
These funds offer greater liquidity to the investor than the corporate bonds that are in the funds’ portfolios, because mutual funds that are available to retail investors, by regulation, must offer daily liquidity (unless exemption is obtained from the regulators). The portfolio manager manages a fund’s portfolio so that the fund can meet daily redemption requests.
In aiming to obtain higher yields that adequately compensate for risk, the portfolio manager carefully oversees the fund, at times negotiating the bond market to exploit liquidity where possible to improve yields.
“The portfolio manager might see a bond that we feel has a greater upside than the seller does, and buy it in the pursuit of higher returns,” says Hicks.
While some stakeholders are calling for regulatory changes that would see greater liquidity in the bond market, not all of the market participants want to see this. Bond dealers can effectively charge for the trading services they provide that others cannot.
“Corporate bonds are designed to perform best when they’re bought and held to maturity,” says Hicks. “Greater liquidity in the bond market wouldn’t improve those returns. If you’re designing your portfolio to maximize liquidity, then you have better options than buying a bond with a longer term than you may be willing to hold it.”
For more information on Lysander Funds, visit: https://www.lysanderfunds.com
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This story was created by Canadian Family Offices’ commercial content division, on behalf of Lysander Funds Limited, who is a member and content provider of this publication.