ALADDIN PERSPECTIVE

SOVEREIGN BOND LIQUIDITY DYNAMICS ON ALADDIN®

Sovereign bonds have experienced a change in liquidity dynamics. Learn how to utilize the Aladdin platform to assess the impact of these changes.

Oct 18, 2022. By Yulia Yudelevich, Director, and Eshan Goel, Vice President.

KEY POINTS

  • 01

    Sovereign bond markets, in particular the UK gilt market, have recently experienced a significant change in liquidity dynamics.

  • 02

    Both the volatility and the bid-ask spreads in the gilt market have nearly doubled over the last two months.

  • 03

    Investors can leverage the Aladdin® tool kit to assess the impact of these market moves on the liquidity profile of the sovereign bond holdings in their portfolios.

Analyzing Sovereign Bond Liquidity Dynamics with the Aladdin® Platform

Sovereign bond markets, in particular the UK gilt market, have recently experienced a significant change in liquidity dynamics. At the height of the liquidity crunch in the gilt market, the Bank of England conducted an emergency bond-buying program that lasted several weeks. In light of these events, and with liquidity still top of mind for many investors, we have looked at how the Aladdin® platform can help clients analyze changes in liquidity dynamics across different markets.

In the first two weeks of October, we observed:

  • Liquidity, as measured by trading volumes, has been increasing, especially in the UK after the Bank of England’s end-of-September intervention. But this action was accompanied by a significant widening in bid-ask spreads and market volatility—pointing to much higher transaction costs.
  • Both the volatility in the gilt market (as measured by the UK 10-year factor) and bid-ask spreads have almost doubled over the last two months.

Aladdin liquidity models utilize bid-ask spreads, volatility, and average daily trading volumes as the main inputs into liquidity assessment of a portfolio’s holdings.

Volatility and Bid-Ask Spreads: UK Gilts vs. US Treasuries

Two graphs showing the comparison between UK Gilts vs US Treasuries for volatility and bid-specific spreads.

Trading Volumes: UK Gilts vs. US Treasuries

Two graphs showing the comparison between UK Gilts vs US Treasuries for trading volumes.

Institutional investors can leverage the Aladdin tool kit to assess the impact of these market moves on the liquidity profile of sovereign bond holdings in their portfolios. One of the tools applies liquidity stressors to see the impact of a recent increase in trading volumes and spread widening.

Using Aladdin tools, clients can quantify how much more expensive it is to trade and how much more difficult it is to liquidate assets.

As an example, consider a hypothetical UK Gilt portfolio 1 to illustrate the impact that changes in liquidity dynamics would have on trading costs and the ability to liquidate portfolio holdings.

Stress Testing a Hypothetical UK Gilt Portfolio

Two graphs showing transaction costs and liquifiable amounts for hypothetical UK gilt portfolio.

In this example, it would cost 2.5 basis points (bps) of the net asset value of the portfolio to liquidate 25% of the positions on a pro-rata basis over five days. The same cost before applying a stress was 1.4 bps.

What’s more, the same behavior can be seen on the “readily available” liquidity side, where a manager can now only liquidate 18% of the fund over one day, compared to approximately 30% without any market stress (with a 2 bp transaction-cost constraint).

The Aladdin® platform provides flexibility and enables institutional practitioners to overlay their current views to get better insight into their portfolios and how they might respond to stressed liquidity conditions.

Footnotes

1 £10mm face value of all the constituent bonds of the ICE BofA UK Gilt index.

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