High-yield market participants say transparency in the credit markets is rearing its head, with the National Association of Securities Dealers' Trade Reporting and Compliance Engine (TRACE) hampering the ability to trade large blocks of bonds in a declining market. Additionally, they argue TRACE, which began offering transaction and price data on the entire universe of corporate bonds in February, has increased market volatility overall as even relatively small trades can quickly cause the market to reprice.
On the heels of the General Motors saga, the Merrill Lynch High Yield Master II Index widened from a historically tight 271 basis points over Treasuries in mid-March to its mid-May low of 460bps. It then rebounded to 413bps over on May 31.
Officials at Street dealers say they have fewer incentives to buy large blocks of bonds with the implementation of TRACE. The pain is felt most in a down market, such as ones that occurred in 1998 or 2002. "If you're a big mutual fund, you'd come to us and say you need to sell $50 million quietly. If the market was for 79/80, we'd bid 77 1/2, leak out chunks and be out of $25 million by the time the market caught up," explained the head of high-yield trading at a bulge bracket firm. Yet now, with the market readjusting after one trade and its display on TRACE, dealers have a difficult time taking on that risk, he added.
Harry Resis, director of U.S. fixed income at Henderson Global Investors in Chicago, agreed the incentive is taken away for the sell side. "They're taking on a big block and then the print hits TRACE and everybody knows what the price and size was. It's not likely anybody will want to pay more. The risk taken is shown on the shirt sleeves of the dealer," he noted.
While the transparency afforded by TRACE came at investors' bequest, larger investors have found their liquidity hampered in recent months as the market has turned. "It's been a permanent knock on the market and dealers are saying that's why they're more reluctant to trade," lamented one portfolio manager at a sizable high-yield fund. Another large high-yield manager agreed, calling transparency a double-edged sword and said it has been more difficult to sell out of positions as the market trended downward. Still, Resis noted for smaller investors such as himself the price transparency has been beneficial.
Tom Hollomon, spokesman for the NASD did not return a call.
