Bond Giant Fretting ETF ‘Blowout’ by 2020 Buys Swaps Instead

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The U.K.’s largest active manager is taking up arms against what it sees as an imminent liquidity crunch coming to credit markets.

As bouts of late-cycle volatility prompt fears of an impending race for the exits, Aberdeen Standard Investments has been scooping up securities with greater liquidity relative to cash bonds, like credit default swaps.

But while holdings of the derivatives have never been higher in Luke Hickmore’s portfolios, the fixed-income manager is bucking a trend that’s taken hold among many of his peers: He’s shunning exchange-traded bond funds, fretting a “blowout” in the passive space within the next two years.

“If you’ve been in the market long enough to remember past blowouts, you know that liquidity is key,” Hickmore said in an interview in Edinburgh, where the $736 billion asset manager has its headquarters. “High-yield credit and emerging-market ETFs won’t be well placed to handle a liquidity crunch.”

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That’s a somewhat contrarian view. Liquidity fears are a big reason fixed-income money managers have piled into bond ETFs, which like CDS are easier to buy and sell at short notice than cash bonds. But Hickmore reckons many funds in the space have become too inflated, and they may now struggle to cope with a rush of redemptions.

Record high trading volumes on U.S. swap indexes underscore how managers have become obsessed with finding instruments that will let them stay nimble in a downturn. Angst over vanishing liquidity was the chief concern among credit buyers in Europe, according to Bank of America’s client survey in August.

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“In the later part of the cycle, we’re getting more and more into short-play stories and it’s important to have the liquidity to exit quickly,” Hickmore said.

Instead of buying sterling-denominated junk bonds earlier this year, Aberdeen bought swaps on Virgin Media, which were more liquid, according to Hickmore.

He also opted for CDS over cash bonds when Spain’s Banco Bilbao Vizcaya Argentaria SA sold off amid concern over possible loan losses in Turkey, and traded swaps linked to metals giant Glencore Plc to get exposure to copper prices.

Before the latest batch of CDS contracts expired at the end of the first half, Hickmore’s portfolios had about 10 percent invested in the securities, he said.


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