In our fourth edition of this blog series on 144A bonds, we explore the liquidity characteristics of 144A bonds relative to non-144A bonds, the latter of which are more often held in large cap high yield bond mutual funds and ETFs.
If you have not yet read the first three installations of this blog series, here are links to get you started:
- Part 1 - 144A Bonds and Why We Buy Them - discussing the nature of these securites, their increasing importance in the high yield market, and why DDJ believes that institutional investors seeking exposure to high yield should embrace investing in Rule 144A issuances.
- Part 2 - The Prevalence of 144A-For-Life Bonds – elaborating on an important trend in the high yield bond market: the prevalence of so-called “144A-for-life” high yield bond issuance (e., those issued without registration rights) relative to 144A high yield bonds issued with registration rights.
- Part 3 - 144A High Yield Bond Ratings and Heightened Yields – exploring the difference in yields and rating agency classifications between 144A high yield bonds relative to non-144A high yield bonds.
Liquidity is an important topic regarding 144A bonds in the high yield market. While DDJ does believe that some liquidity premium remains in the 144A high yield bond market when compared to non-144A high yield bonds, the size of such premium has decreased significantly as the 144A market has grown and matured.
Furthermore, DDJ believes that any discussion of liquidity conditions in the 144A high yield bond market must take into account many of the factors discussed in previous blogs within this series, in particular the ratings composition of 144A high yield bonds relative to SEC registered high yield bonds.
The exhibit below breaks down the percentage of total high yield bond trading attributable to 144A high yield bonds based on average daily trading volume over the last six and a half calendar years. Also displayed is the percentage of the total high yield bond market represented by 144A bonds. To the casual observer, 144A high yield bonds do not trade as frequently as one would expect given their relative size in the high yield market. At DDJ, however, we believe that simply looking at aggregate statistics to reach a conclusion oftentimes can be misleading, and such is the case in this instance.
Trading Volume and % of Market
DDJ believes that the lower ratings bias and private nature of many 144A bond issuers causes such issues to be excluded from many of the large cap high yield bond mutual funds and high yield bond exchange traded funds (“ETFs”). These mutual funds and ETFs – and more specifically, the bonds that they hold – trade frequently because investors use these vehicles to tactically, rather than strategically, invest in the high yield market. Such trading activity can be concentrated in the largest and most liquid issues in the high yield market, and therefore impacts aggregate market trading statistics, such as trading volume. As a result of such ETF and mutual fund trading activity, trading volumes of bonds outside of this largest/most liquid group of bonds may appear artificially low in comparison.
While being issued as a 144A bond, and in particular as a “144A-for-life”, may have meaningfully reduced a bond’s liquidity in the high yield bond market many years ago, given the growth and maturity of the 144A market, DDJ has found that 144A bonds offer sufficient liquidity in order for DDJ to execute its high yield investment strategies on behalf of its clients. From DDJ’s perspective, the overall size of an issue, rather than whether the bond is issued as a 144A or SEC registered bond, tends to have a much greater bearing on a bond’s liquidity (with larger issues generally being more liquid than smaller issues, all other things being equal).
Interested in taking deeper dive on 144A bonds? Download the full whitepaper below (originally published in November 2018).
DDJ Capital Management is a privately held investment manager for institutional clients that specializes in investments within the leveraged credit markets. Since our inception in 1996, DDJ has sought to generate attractive risk-adjusted returns for our clients by adhering to a value-oriented, bottom-up, fundamental investment philosophy. DDJ has extensive experience investing in securities issued by non-investment grade companies within the lower tier of the credit markets, including high yield bonds, bank loans and other special situation investments.
The information and views expressed herein are provided for informational purposes only, and do not constitute investment advice, are not a guarantee of future performance, and are not intended as an offer or solicitation with respect to the purchase or sale of any security. The inclusion of particular investment(s) herein is not intended to represent, and should not be interpreted to imply, a past or current specific recommendation to purchase or sell an investment. Any projections, outlooks or estimates contained herein are forward-looking statements based upon specific assumptions and should not be construed as indicative of any actual events that have occurred or may occur. This material has been prepared using sources of information generally believed to be reliable; however, its accuracy is not guaranteed. Investing involves risk, including loss of principal. Investors should consider the investment objective, risks, charges and expenses carefully before investing with DDJ.
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