Bond Revolution in Singapore – Lesson 9 : Handling A Crisis

Let’s face it.

By the time the man on the street knows there is a market crisis, we would be well into it already.

This is perhaps one of the more relevant posts I will be writing for the retail bond investor for a long time – How to cope in a crisis.

One of my first lessons to a young trader would be that you can trade well 99% of the time or 364 days of the year, but the mark of a true trader is how they manage that 1 day (or more) crisis.  That is the same for the investor.

Crises come in many forms – specific credit crises, natural disasters, terrorism and so on.  The collateral damage can be contained or widespread.

Let me recount how a typical crisis unfolds in the trading floor for a corporate bond book.

1. Pre Crisis – you scent the whiff of trouble in market chatter and behaviour of large institutional clients. You start assessing your holdings and make a list of those to dump or hedge.

2. First Wave – more clients get involved now, including large private banking clients who are members of the markets. Calls start coming in mostly asking for bids and you start shading the prices down by several % to dissuade the sellers. Sometimes you will get hit which is a shame.

3. Full Blown – news hits the mainstream. Sales desks phones ringing off the hook, all 8 phone lines buzzing away. Sales desk picks them up selectively. Instant messages coming in from all clients asking for bids (usually). also answered selectively.

4. Banks and institutions always have to have a liquidity action plan which means the big institutions will be selling part of their portfolios to raise cash eg. during the time of AIG failure or bank runs. Traders have the option to cherry pick the crown jewels, rejecting the sour names unless there is arm twisting involved, which happens more often than not.

5. Private banks will be calling when their clients hit margin calls and dumping bonds too, which the sales desk will prioritise last.

6. Trader’s priorities – bond limits, bank’s reputation and P&L. My first question is usually if they had bought the bond from us directly ? (third party deals will not affect the bank’s reputation as much)

7. Sales desk will wisely request for prices, prioritising their clients because every call to the trader will almost always attract a certain tonnage of abuse.

8. Typical evasive tactics/excuses, “No more limits”, “Trader off desk”, “We just got hit”. Or really way off prices, 10-20% lower than the last done price. For all intents and purposes, even if I had limits for a contagious name, I would not risk buying it at anything less than a huge discount. And if I already had the bond in my book, I would not transact it lower as it would affect my marked price and cause a big loss.

Private bank clients not from your own bank, tend to get the least attention for the smaller amounts and there is little chance of a deal unless they had bought the bond from you in the first place. That is not to say that they lack clout, because there are clients powerful enough to force a price out of their hapless salesman who will probably walk over to the trader to explain quietly the necessity of the deal (so the other sales people would not complain of double standards).

Crises are also bargain hunting times for those who are prepared. There is opportunity to make big returns in flipping/turning over papers because the bid-offer spreads are wider than usual. Of course the priority again is in quantity although there are some axes that will be shown to the private banks for them to place orders that may or may not be executed.

Communication is patchy, nerves run raw and stress levels are high. If you are holding on to a potentially defaulting paper like I was in various times, errrr, it is a much worse feeling.

Of course there were crises like 9-11 did not give markets a chance, skipping step 1 and 2 altogether.

From the investor’s perspective, a crisis an an opportunity too. I realise from experience that most people run and hide under their pillows during this time, to emerge only after calm has settled.

Why buy a bond at 100 and not buy more of it at 70 ? If you liked it at 100, surely 70 would be even more appetising ?

My sympathies for those on margin calls too. Because that is when you part with the crown jewels and still sit on the junk and I personally know how that feels too ( I am not such a good investor).

Fortunately, as I write, we have not seen a major crisis in a long time. We had bouts of little troubles in the past 6 years since the Lehman crisis and even a mini EM rout last year which presented bountiful opportunities to buy bonds at incredibly low prices, SGD bonds included.

Conclusion

• There is no warning for crises especially for the retail investor.
• There is very thin OTC market liquidity during a crisis.
• Do not wait for someone to tell you what to do, including hedging your portfolio.
• Do not attract margin calls.
• There are opportunities to position and to buy during a crisis.
• Crises are good for you.

I realise that this lesson is only partially complete because we have not discussed the various bond classes and the crisis effects.

That would have to come in another lesson.

PS : My instincts are scenting the whiff of risk aversion. Italian and Spanish yields are widening against the German bunds to levels not seen since Mar.

Volatility is at lows which suggests the market at large is unprepared.

Valuations and prices are at their extremes.

It is a perfect recipe for a mini crisis to unfold, not that I am wishing out loud for one. But it would be timely to be prepared.

Afterword

I am pleased to present a reader’s comments, taken from another post, recounting their experience and sharing their lessons.
link : https://tradehaven.net/market/bonds-in-conversation-its-all-about-debt/#comment-2872