Liquidity from all angles

At the peak of financial-markets turbulence in March, liquidity across the spectrum of risk assets evaporated. Fund managers say the Reserve Bank of Australia’s measures have largely reversed this and liquidity has returned in primary and secondary markets as well as in client flows.

Liquidity problems began in March and snowballed when the federal government announced plans to allow early access to superannuation, leading to large redemption calls on domestic fund managers. However, by late June fund managers say these issues have largely played out and even reversed.

Investors say secondary-market liquidity has greatly improved from March, to the point where they can execute typical sector rotations between semi-government and supranational, sovereign and agency (SSA) bonds.

Darren Langer, senior portfolio manager at Nikko Asset Management, says liquidity is only part of the contemporary equation, however. He explains that investors and banks are driving spreads in quickly, but not evenly. Volatility between sectors is higher than usual and this creates switching opportunities.

The SSA sector has often been perceived as relatively illiquid compared with semi-government bonds in Australian dollars. Sonia Baillie, head of credit at AMP Capital, says this led AMP to be underweight in SSAs prior to the crisis due to the perception that a stress event may be on the horizon. “No-one anticipated COVID-19, but we were cautious on the macroeconomic outlook and were running severe stress and liquidity tests on our books,” she reveals.

Investors report it was as difficult to sell a triple-A semi-government bond in March as it was to sell a lower-rated SSA. However, the stress event does not appear to have changed perceptions of liquidity to the extent that investors would prefer to hold the higher-yielding SSA paper purely for the compensation of extra spread.

Tamar Hamlyn, principal at Ardea Investment Management, tells KangaNews fixed-income securities performed in line with expectations aside from a brief period in March. He says governments and central banks have taken sufficient measures to make this experience unlikely to repeat. Rather than shifting assumptions on fixed income, Hamlyn says the crisis has validated them.

“Our experience of investing in Australian dollar fixed income is that relativities change over time. Sometimes semi-government bonds may be cheap and at other times it may be SSAs. If we can switch between asset classes, it is a natural function of markets and an attractive source of return,” he explains.

Client flows

Fixed-income funds faced intense pressure from client redemptions in March and April, as individuals took advantage of early superannuation access at the same time as a reallocation of funds into the bottomed-out equity market was occurring.

The market has moved past this phase, though. The superannuation call ultimately was not as large as initially expected and the rebound in fixed-income spread and liquidity has led to cash being redeployed in the sector.

Hamlyn says: “Yields now offer less outright value but many people are still concerned about the outlook while returns in other asset classes are uncertain. In this environment, the role of fixed income as a safe and secure store of capital for people with low risk appetite is clear.”

Australian dollar sovereign-bond yield is low but has gone back above that of the US. All else being equal, these dynamics could be expected to attract more international flows into Australian fixed-income funds.

Anthony Kirkham, head of investment management and Australia and New Zealand operations at Western Asset Management, says the pace at which allocations are flowing out of Australian fixed income and into the US has slowed.

However, the Australian dollar has also strengthened relative to yen and US dollars. This means the factors drawing international funds into Australian fixed income are offset to some extent by those prompting existing international investors to take profit on their Australian dollar exposure.