A year into the credit crisis, the lack of liquidity in many market segments might hold long-term opportunities for money managers willing to sift through the mound of depressed investments.
As cash-strapped Wall Street firms curtail principal trading, speculators think twice about the cost of funding positions and traditional investors shy from risk, liquidity has dwindled in credit markets, driving spreads wider and prices to bargain-basement levels.
For instance, high-yield debt spreads rose 175 basis points since May, to 812 basis points, more than three times the all-time low of 241 basis points set in June 2007, according to the Merrill Lynch & Co. High-Yield Master index.
The lack of liquidity creates a punishing environment for those who need to exit the market in a hurry, but it also holds potential rewards for those armed with cash, patience and a good sense for fundamental analysis.
“Cash is king in this market. But you have to be willing to spend it when you see an opportunity,” Zane Brown, principal and fixed-income strategist at Lord Abbett & Co., said in an interview.
He also stressed the importance of knowing the fundamentals when looking for bargains. As an example, Mr. Brown said his Jersey City, N.J., firm, which has $100 billion in assets under management, recently bought municipal debt at a good discount because the holder of the high-quality securities needed to quickly raise capital to buy a new issuance.
“Liquidity is one of the factors that drive the investment style. If we get involved in a transaction, liquidity is always an important issue,” Mr. Brown said. He noted that some parts of the credit market, currently hurt by a dearth of liquidity, involve large spreads that will look very rewarding once the financial storm passes.
“You have broad differences in high-quality vs. low-quality securities. But that, too, will change and return to a narrower differential,” he predicted.
A good indicator of liquidity in a debt market is investors' appetite for new issuance.
For the year to date through Aug. 8, U.S. issuance of high-yield corporate bonds plummeted 61%, to $35.8 billion, vs. the same period in 2007, while issuance of investment-grade bonds was down 15%, to $457 billion, according to data provided by analytics and consulting firm Dealogic, New York.
The volume of new asset-backed securities dropped 79%, to $123.1 billion, over the same period. Mortgage-backed debt issues have plunged amid the deepening housing crisis — commercial mortgage-backed securities collapsed 97%, to $5.2 billion, while residential mortgage-backed paper fell 77%, to $126.9 billion.
“There is a relation between the liquidity in a given market and the issuance of new paper,” said David Resler, chief economist at Nomura Securities International Inc., New York. “If there is nobody willing to buy the paper, there is no point in trying to issue it.”
The now-infamous collateralized debt obligation market has come to a standstill, down 93% year to date through Aug. 8.