by Wayne Bowers, Chief Investment Officer – International at Northern Trust Global Investments
Risk and return … how things have changed, or more importantly how things are changing … with the well-understood events surrounding the ongoing credit crunch and the potential / actual spread of tighter lending conditions, it is natural to question if we are going through a ‘temporary’ impairment of liquidity and issuance or if the last six months will result in a significant shift of capital market issuance behaviour.
Investor appetite in the front end of the yield curve now clearly understands the term ‘structure risk’. This risk can now be differentiated from ‘credit risk’ and also ‘liquidity risk’. There are clear and measurable price and yield differences between those securities that exhibit various levels of structure, credit and liquidity risk, whereas perhaps in prior years these risks have not been differentiated and priced accordingly, seemingly blindly off a stable libor curve. This has driven investors to demand, require and get used to a return requirement equally measured off a libor curve, with perhaps indifference to the levels of structure, credit or liquidity risk that the underlying securities contain.
Perhaps what the last six months have taught us most is the heightened level and need to better understand the structure of a security:
- Single corporate issue versus structured credit commercial paper
- Credit quality – here I mean not the ‘official’ rating but the underlying quality and potential for upgrade / downgrade
- Last but not least, the liquidity available in the underlying security – a bank issued certificate of deposit versus a structured credit floating rate note.
An understanding and need for price / yield differentiation is now required by investors and quite rightly so, for those securities with different levels of risk. What does this mean for issuance trends in coming months and quarters?