Photo Credit: Bowen Chin || What’s more Illiquid than Frozen Tundra?
My last piece on this topic, On Bond Market Illiquidity (and more), drew a few good comments.  I would like to feature them and answer them. Here’s the first one:
Hello David,
One issue you don’t address in your post, which is excellent as usual, is the impact of what I’ll call “vaulted†high quality bonds. The explosion and manufacturing of fixed income derivatives has continued to explode while the menu of collateral has been steady or declining. A lot of paper is locked down for collateral reasons.
That’s a good point.  When I was a bond manager, I often had to deal with bonds that were salted away in the vaults of insurance companies, which tend to be long-term holders of long-term bonds, as they should be.  They need them in order to properly fund the promises that they make, while minimizing cash flow risk.
Also, as you mention, some bonds can’t be sold for collateral reasons.  That can happen due to reinsurance treaties, collateralized debt obligations, accounting reasons (marked “held to maturityâ€), and some other reasons.
But if the bonds are technically available for sale, it takes a certain talent to get an insurance company to sell some of those bonds without offering a steamy price.  You can’t sound anxious, rushed, etc. My approach was, “I’d be interested in buying a million or two of XYZ (mention coupon rate and maturity) bonds in the right price context.  No hurry, just get back to me with any interest.† I would entrust this to one mid-tier broker familiar with the deal, who had previously had some skill in prying bonds out of the accounts of long-term holders before.  I might have two or three brokers doing this at a time, but all working on separate issues.  No overlap allowed, or it looks like there is a lot of demand for what is likely a sleepy security.  No sense in driving up the price.
