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Addressing Corporate Bond Liquidity Challenges

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Addressing Corporate Bond Liquidity Challenges

The widening imbalance between credit supply and demand has exacerbated liquidity challenges.

These challenges have the potential to impact fixed income strategies, particularly indexed portfolios, including higher transaction costs, difficulty tracking market changes, and increased exposure to difficult-to-trade securities.

Fixed income market making and secondary trading for dealers has been stifled by Dodd-Frank regulations and stiffer capital requirements. Post financial crisis, dealer inventory (supply) has decreased while corporate bond issuance and AUM have increased, reflecting increasing demand. 

Trading volume also illustrates the reduction in liquidity.

Even as the average corporate debt outstanding grew by more than 125% between 2002 and 2013, average corporate debt traded daily fell by almost half (source: SIFMA, FlexShares). FlexShares Credit-Scored US Corporate Bond Index Fund (SKOR) is backed by an index that utilizes a distinctive investment universe, liquidity screens and other constraints to help manage these liquidity challenges. The index also features a fundamentals-based credit evaluation process that is forward-looking and focused on the metrics we believe matter in the fixed income space: management efficiency, profitability and solvency.

SKOR METHODOLOGY
 

  • Beginning with Northern Trust Investment Grade US Corporate Bond Index, SKOR limits its investable universe to bonds issued by publicly traded companies, issues with $500+ million in outstanding principal and the top 80% of issuers based on outstanding market capitalization of debt. This provides a broad opportunity set of bond issues while retaining index characteristics similar to traditional intermediate maturity bond indexes.
  • Next, eligible issues are scored based on the credit fundamentals of management efficiency, profitability and solvency.
  • The issues are then optimized based on credit score, option-adjusted spread and effective duration while diversifying the portfolio using security, turnover, credit score, issuer and sector constraints. These constraints are intended to avoid the risk of large security, issuer or sector bets and reduce transaction costs.
  • The index is rebalanced monthly.
     

To learn more about SKOR, visit us here.

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