By Donald A. Steinbrugge via Iris.xyz
With rising interest rates and fairly tight credits spreads, are there still opportunities with fixed income oriented hedge fund strategies? Agecroft Partners recently spoke with five leading hedge fund industry experts who will be presenting on the “Opportunities in Fixed Income Oriented Hedge Fund Strategies” panel in early November at Gaining the Edge – 2018 Hedge Fund Leadership Conference in NY. Panelists include, James J. Challen, CFA, CAIA, SVP Principal, LCG Associates, Tom Williams, CFA, CIO Pine Grove Funds, Man FRM, Cedric Fan, CFA, Senior Portfolio Manager, Russell Investments, Brian Walsh, Principal & Chief Strategist Titan Advisors and Thierry Adant, Consultant for Credit Willis Towers Watson.
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Brian Walsh of Titan Advisors mentioned that he has been focused for a while on how the structure of markets and liquidity has changed over the past decade. He provided a very interesting statistic: “In 2008, corporate bonds outstanding were $2.8 trillion, and dealer bond inventories were $269 billion (close to 10%). Today the respective numbers are $5.3 trillion and $40 billion (less than 1%). So bonds outstanding have essentially doubled while dealer inventories are down 85%. This is a classic example of unintended consequences of government regulation. The next crisis or accident will most likely be a liquidity driven one.”
This change in market dynamics has both negative and positive consequences. On the negative side there is significantly more tail risk in many fixed income strategies than most investors realize, which will be a result of market liquidity drying up. It is important to stress test a fixed income strategy to see how it performs in a less liquid scenario. It is also important that strategies investing in less liquid securities have liquidity terms appropriate for the strategy. These include length of notice period for redemption and gates or a private equity structure. Properly structured, these funds can successfully weather a short term liquidity crisis.
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