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Find problems and you will be more effective at moving people, argues author Daniel Pink in his book To Sell is Human. Four-point-three trillion dollar fund management powerhouse BlackRock appears keenly aware of this phenomenon. In a recent opinion piece, BlackRock called out a problem: “We believe the secondary trading environment for corporate bonds today is broken.” Fair enough. Compared to the 5,000 or so public stocks trading on exchanges, there are around 46,000 separate corporate bonds outstanding with vastly differing legalities hidden inside. As an analogy, consider two light bulbs, one representing the equity marketplace and one representing the corporate bond marketplace. Light bulbs are meant to generate light, not heat, which is simply wasted energy. Equity markets are those twisty light bulbs that barely give off any heat. The corporate bond market is like Thomas Edison’s first rough draft light bulb, sending off enough heat to give you a second-degree burn. BlackRock wants to transform Edison’s rough draft into a twisty new age bulb – that is, to make the corporate bond market more like the stock market. BlackRock cares about corporate bond efficiency because it holds a lot of corporate bonds and liquidity is drying up. As a percent of total debt outstanding, at 70% (compared to 120% in 2005) corporate bond trading is historically low due to regulation limiting the amount of risky assets bond dealers hold on their balance sheets. Less liquidity means more volatility. Even though volatility is low right now, the corporate bond market may be headed for a crash, as the Financial Times pointed out in a response to BlackRock’s memo. While this issue should not be taken lightly, for investors in separately managed accounts who can be selective about which bonds to buy or sell a period of heightened volatility can also present astute investors with uncommon opportunities to find bargains on quality securities.
As a response to the looming problem, BlackRock advocates creating more “all-to-all” trading venues to improve liquidity. In 2012, BlackRock launched just such an “all-to-all” trading platform, the Aladdin Trading Network. Dealer balance sheets and regulation would matter less if wide adoption of Aladdin took hold (and BlackRock would be paid for processing transactions) because the PIMCO's and Fidelity's of the world could simply trade with each other. Though it was not a bad idea, it did not catch on. In 2013, BlackRock shelved further development of the Aladdin Trading Network. This may be the reason why in their recent memo, after calling for corporate bond standardization and updating e-trading protocols (additional steps toward making bond trading a new age light bulb), they threw their hands in the air, nebulously calling for “behavior change from all stakeholders.” BlackRock put into writing the frustration that a lot of asset managers, including SNWAM, feel. When the next crisis occurs, our clients may need to redeem cash to, say, pay salaries at their small business. Lower corporate bond liquidity may reduce the amount of cash we can return to them when selling corporate bonds. That said, our taxable bond portfolios have substantial allocations to Treasuries and Agencies, which continue to offer ready liquidity even in the most volatile markets.
Sources: Daniel Pink, Financial Times, BlackRock, WSJ