By Ryan D’Souza
The recent increase in exchange activity has quietly clouded market transparency, creating significant opportunities for active managers to add value.
Transparency and competition in the municipal market have greatly improved with advances in regulation, electronic platforms and algorithms. Additionally, liquidity conditions have remained stable since the Federal Reserve introduced the Municipal Liquidity Facility following the pandemic-induced sell-off in March 2020. Although bid-ask spreads have widened amid increased volatility in 2022, the high selling pressure was absorbed in a more orderly fashion. this time. The year-to-date increase in trading volume also reflects a sharp increase in swap activity, which has distorted typical market signals and rewarded those who remained vigilant.
This problem is compounded by investors’ reliance on comparable trade data to support bond valuations. Although trades are published soon after they are executed, swap trades appear indistinguishable from spot trades in this data. And with swap trades inherently organized on a relative value rather than an absolute return basis, investors are likely to misattribute these trade levels, which will result in liquidity demand illusions on the whole market. Tax loss trades, which have become particularly prevalent, are additionally usually executed in large blocks, producing trade drawdowns that appear to establish a particular trading level. Subsequent investors may naively perceive that liquidity exists at the established level, seeking to execute and continue the cycle until a larger spot transaction changes the market price. In addition to tax-loss swaps, the volatility has prompted dealers to swap out-of-date stock items more frequently to bring seemingly fresh deals. Amid this momentum, passive and non-traditional investors can see value where there is none.
We believe that a diligent approach to market liquidity analysis helps us discern these mispricings perpetuated by swap swaps, which we believe deviate from fair value by 20 to 30 basis points. basis, in our view. The basis of this approach is to monitor new issue price levels and subscriptions, as well as requested trade impressions, which we believe provide the clearest signals of liquidity demand. Additionally, we believe that accurately tracking secondary business flow requires in-depth knowledge of current secondary offerings and markets, as well as in-depth market color gleaned from strong dealer relationships. Using this knowledge, we refrain from what we believe to be mispriced bonds, while continually looking for value in the rest of the market. By positioning ourselves to capitalize on corrections and performing at more optimal levels, we believe we can significantly improve the performance of our customers.
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