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Judging liquidity like ‘trying to hug clouds’

Amanda White




Addressing inflation will also allow other risks in fixed income to be managed, according to Tamar Hamlyn, principal at Ardea Investment Management.

“If investors address portfolio robustness with regard to inflation, then you will also address some of the other risks in fixed income,” he said.

“We’re worried about the risk of inflation. What does that have to do with yield? Only in low inflation environment[s] will people lend large amounts of low yields for an increasing length of time. Inflation allows all of that to happen.”

Inflation expectations appear to be remarkably naïve,” he said.

“It means there are things we can do to take advantage of that market pricing. But everyone in this room can do better than assuming inflation is flattening and just around 2.5 per cent. It probably won’t do a flat line and we need to be conscious of that in constructing portfolios.”

Hamlyn said one of the most interesting things in markets at the moment is the number of extremes. For example equities are at all-time highs, but bond yields are at record lows.

“This is an enormous anomaly we need to consider in constructing fixed income portfolios. There is no getting around these uncomfortable dynamics,” he said.

“The most obvious is debt to GDP with gross public debt going from 80 per cent to 120 per cent in 10 years. Yields are now half of 1 per cent, and 10 years ago they were 3-4 per cent; there is an extension or lengthening of maturities. It’s the opposite of what you want in every single case.”

In another session addressing volatility, Matt Toms, head of fixed income and portfolio manager at Voya, said there is concern regarding the volume of debt.

“US debt markets are outpacing US real GDP, there is too much debt to move through the pipes,” he said. “But we believe that markets have priced in this lack of liquidity. Most market participants have a plan, so this is not an incrementally more difficult environment.”

Toms said the market is bifurcated between smaller managers and larger managers.

Larger managers can get access to primary issuance, but to sell liquidity becomes distorted to the smaller managers.

“Protection against downside risk is easier for smaller managers,” he said.

While he believes the market has adjusted, market volatility will increase.

“One of the unintended consequences is people who are not great macro managers playing in those areas. There is an increasing use of macro tools to trade, but you must ensure your managers have those skills.

“Judging liquidity like trying to hug clouds,” he said.

Sitting on the same panel, James Murray, head of liability management, derivatives and defensive assets at TCorp, said investors need to get better at managing liquidity budgeting to avoid deadweight costs.

“Budgeting needs to become more embedded,” he said. “Make sure you are getting paid for assuming liquidity.”