Interesting Observation Regarding Corporate Bonds

A very interesting observation today compliments of Bloomberg.

Basel 3 and QE has resulted in more distortions in the global corporate bond market. We now see negative swap spreads implying that investors believe corporate bonds are less risky than US treasuries. We believe this is due to the ongoing search for yield in a low interest rate environment and the resulting mispricing of risk.

Additionally we now see negative inventory of corporate bonds as Basel 3 discourages banks to hold such assets due to additional capital requirements. One of the long term negative implications of this is that banks still access credit quality when lending to corporates but then sell the assets off balance sheet to yield hungry investors.

Sound familiar? Think Collateralized Debt Obligations, Mortgage Backed Securities and the GFC.

We are concerned regarding the lack liquidity in the corporate bond market and the mismatch of duration between the underlying security and the promise of daily liquidity within mutual funds and exchange traded funds.

This is one of the reason why we hold a significant above benchmark weighting to cash despite the low yield. Here is a link to the Bloomberg article for reference.

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