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Text on screen: Jerome Schneider, Head of Short-Term Portfolio Management
Jerome Schneider: We view liquidity through two different lenses primarily: market liquidity, and portfolio liquidity.
Text on screen: Market liquidity: The ability to buy and sell bonds efficiently, continuously, and economically
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With regards to market liquidity, we want to think about how instruments that we can transact in can typically be effectuated. For fixed income, it's primarily through over the counter. Thus, when we find during times of stress that liquidity can disappear, oftentimes with wider-bid offers, lower efficiency, higher economic cost, we want to be mindful of how we transact risks for those clients in those portfolios and minimize cost, and most importantly, maximize capital efficiency at that point in time.
Text on screen: Portfolio liquidity: The structuring of a portfolio to be consistent with desired strategy objectives
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With regard to portfolio liquidity, we needed to be thinking about how to construct portfolios that are potentially more resilient in these times of stress.
Investors have increasingly become aware of the higher rates and higher yields that many central bank policies have brought to us over the past year. Fortunately, over the past 10 years we've seen
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central bank policies do something else, cut off the left tail and right tail risks of many of the systemic concerns that we had post the global financial crisis. More importantly, today, it's a systematic concern of deleveraging that we need to be focusing on. The higher cost of capital and higher rates are creating more volatility in the market, and opportunity.
FULL PAGE GRAPHIC: TITLE - Daily change in treasury yield has increased since Covid lows. The graphic shows a line graph that measures the 1-day basis point change in the 2-year US Treasury yield against the average absolute change (2.85 basis points) and the average absolute change in 2022 (6.17 basis points). The graph spans the period of December 2019 to October 2022, and a range of -30 basis points to 30 basis points. It shows some basis point volatility around the start of the Covid-19 pandemic, in February, March, and April of 2020, with volatility peaking at a range of 35 basis points, spanning from a -20 basis point change to a 15 basis point change. After this period, volatility remained stable, near zero daily change for the 2-year treasury yield, from April 2020 until September 2021. Around September 2021, when inflation began to increase, change in values became highly volatile, swinging as much as 30 or 50 basis points in a single day. Price swings peaked in June of 2022, as basis point changes jumped from as high as 30 to as low as -25, but remain quite high at present. The graphic helps the reader understand that basis point changes have been particularly volatile in the past year, far more than in other recent periods. It is also the case that the average absolute change in 2022 has more than doubled the average absolute change over the three year period.
For clients, we can actually see this volatility in real time, looking at the front end of the yield curve here in the United States, even the interday volatility of looking at the 2-year note as an example, we can see yields flummox around various points in time to historical proportions in terms of basis points. As we think about the systematic deleveraging, we want to be proactive in trying to insulate portfolios, focusing on the outlook, but also reconciling the changing market conditions, where we can potentially take advantage of opportunities for clients.
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Investors might be finally breathing a sigh of relief, specifically because yields have moved higher in recent months. While these yields are higher, and for the first time in many years, cash and cash-like alternatives are in fact producing returns and income for investors, there's actually an increasingly apparent structural trait — a differentiation in yields amongst these strategies.
Text on screen: TITLE – Cash and cash-like alternatives: BULLETS – Treasury Bills: Zero default risk, Trades at lower yield than Federal Reserve benchmark, Bank Deposits: Offers overnight liquidity, Lower yielding; Investors may be paying for liquidity they don’t need, Short-Term Strategies: Currently may offer 5%+ yield, with a focus on capital preservation and liquidity management
Treasury bills, as an example, trade at a lower yield than even the Federal Reserve's benchmark rate that's set, so you're paying a premium for owning the security of owning a treasury bill through a lower yield.
Bank deposits, while offering overnight liquidity, are also suffering the same consequences of lower yield on average, as investors and banks specifically do not need the liquidity. Finally, when we think about these strategies, short-term strategies, particularly those focused on capital preservation and liquidity management, offer investors a high quality alternative that may offer investors a yield of more than 5 percent the at this point in time. These higher yields obviously are a very drastic environment than what we've witnessed over the past few years. Investors should be proactive in terms of how they should think about cash management,
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and in today's landscape, we believe they will be handsomely rewarded with those potential, while remaining high in quality in short-dated, short-term strategies.
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All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed.
Liquidity is subject to change based on market conditions.
Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.
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This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
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