Most bonds don’t trade – and that could lead to a huge crisis in corporate debt

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A fresh piece of Citi research lands on bond market liquidity, which evokes a reminder of those days in late 2015 when a lot of attention was focused on how easy it was to buy and (more importantly) sell corporate debt.
Back then JNK and HYG, the two biggest high-yield bond exchange traded funds, had fallen to their lowest since 2009 after Third Avenue, a US asset manager, said it would shut down its $788m “Focused Credit Fund” after a wave of losses and investor redemptions.
As most corporate debt doesn’t trade very regularly, the lack of volume could be a problem should a lot of investors want to withdraw money from mutual funds. The funds would have to sell bonds to raise cash for redemptions, which could crash prices and spark more withdrawals, a process similar to thebank runs of the financial crisis.
The problem failed to materialise, everything recovered and the long boom carried on, however. But did liquidity improve?
Not so much, says Anindya Basu of Citi (with our emphasis):

we find that on average, only 18% of the entire corporate bond universe (by CUSIP) traded on any given day. For issues that traded 5 times or more on a given day, the percentage was in the single digits at about 8% [see chart below]. Furthermore, most of these CUSIPs trade in small size – more than 75% of the total volume traded during this period can be attributed to only 15% of the CUSIPs.

The daily churn (or turnover) in bonds is also fairly low (less than 1%) when expressed as a percentage of outstanding notional of the traded bonds [see righthand chart below]. For IG bonds, the average daily churn is 0.35%, for HY it is somewhat higher at 0.56%. The graphs also show that the churn can vary between as low as 0.10% to as high as 0.70%, all of which is well below a 1% threshold. Given that most bonds do not even trade on any given day, the daily churn expressed as a percentage of the total bond universe is another order of magnitude lower.

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