Liquidity is a coward – It’s never there when you want it.
Recently I was listening to an interview with Jeff Gundlach, the CEO and CIO of Doubleline Capital, where he was talking about the liquidity of commercial mortgage backed securities (a type of bond that is backed by mortgages on commercial buildings) and he used that phrase to describe the market in those securities. Until you have actually been in a position that you can’t get out of at a reasonable price you would never understand how true that statement is. Unfortunately in the last week, many high yield bond investors and managers at Third Avenue Focused Credit Fund are finding out how price and liquidity can disappear just when you need it most. (Third Avenue Blocks Redemptions From Credit Fund Amid Losses)
I love clichés. The thing about clichés is that they wouldn’t be around and so heavily used if they weren’t true. In this case, there is a hard lesson to learn. One that can go without notice until you are right smack in the middle of it and wishing there was a way out.
You see in the last 15 years the market has become dominated by computerized trading, and although it has cut the cost of trading for the individual investor, the rise of the computerized trading has had a detrimental effect on the amount of liquidity that exists in the market.
The bond market is the biggest market in the world. At one time the bond traders on the desks at major investment banks were referred to as the “Masters of the Universe” and James Carville once quipped that if there were reincarnation he would like to come back to life as the bond market, because it carried so much sway over the world economy and government policy. But as big a market as it is, the changes in the market structure have reduced the liquidity, and when trying to exit positions that are not widely held in the first place , that lack of liquidity leads to disastrous outcomes.
In Third Avenue’s Focus Credit Fund, the lack of buyers for their portfolio of thinly traded high yield bonds led them to halt redemptions and put the remaining securities into a liquidating trust so that they can have a more orderly sales process. Not the type of liquidity that mutual fund investors were expecting when they invested.