Quiver Quantitative - The rise of electronic trading and the growing popularity of portfolio trading have had an unexpected consequence for the U.S. corporate bond market: making private credit more attractive. Portfolio trading, where investors can buy or sell a group of bonds in one or a few transactions, often via exchange-traded funds (ETFs), now accounts for nearly a tenth of the market's trading volume. This boost in liquidity has flattened the extra yield, known as the liquidity risk premium, that investors receive for holding infrequently traded bonds.
According to Barclays (LON:BARC) (BCS) data, the liquidity risk premium was only 5% of the compensation that investors demanded for investment-grade bonds at the end of last year, down from 30% a decade ago. This reduction has driven buy-and-hold investors, such as insurers and pension funds, towards private debt markets. Jeff Meli, Barclays’ global head of research, noted that the diminished need for liquidity in public markets has increased demand for private credit.
Market Overview:
- The rise of electronic trading and credit ETFs is impacting the corporate bond market and driving investment into private debt.
- Increased liquidity from portfolio trading and ETFs has reduced the "liquidity premium" for less frequently traded bonds.
- He anticipates data centers clustering in regions with cheaper electricity and government subsidies.
- This diminished reward incentivizes institutional investors like pension funds to seek higher yields in private credit markets.
- The trend towards private debt could continue as electronic trading further enhances credit market accessibility and liquidity.
- Traditional fixed income funds might need to adapt their strategies to account for the changing landscape.
- The long-term viability of private debt as a high-yield alternative depends on managing potential drawbacks like illiquidity.
Jean Hsu, managing investment director of private debt at CalPERS, highlighted the trend at the Milken Global Institute Conference, stating that the pension firm plans to increase its exposure to non-public assets to 30-40% of its portfolio from 20%. The shrinking liquidity premium has made alternative investments more appealing, pushing investors to allocate more towards private markets.
The explosive growth of credit ETFs has also played a significant role in this shift. At least three dozen credit ETFs have launched this year, on top of the 110 that debuted in 2023, according to Bloomberg Intelligence. These ETFs have around $340 billion in assets with an average trading volume of about $150 billion per month. The increased liquidity provided by ETFs has made credit markets more accessible and efficient, driving the trend towards private credit as investors seek to capitalize on the evolving market dynamics.
This article was originally published on Quiver Quantitative