– The credit markets have become more concentrated since the global financial crisis, limiting market liquidity provided by financial institutions.
– Exchange-traded funds (ETFs) have emerged as an alternative source of liquidity, but their high concentration and trading algorithms create volatility and higher liquidity costs.
– Passive investing has put pressure on active managers’ business models, and the scalability of alpha generation is a challenge for large funds.
– Active managers may need to adapt their alpha-generation skills to achieve scalability, as scaling up may lead to diminishing returns.
– The probability of selecting the right manager with alpha-generating skills is comparable to a random coin toss.
– Investors face concentration risks and increased liquidity premiums when investing in ETFs, while active managers face sizeable challenges in delivering alpha.
– Quantitatively driven credit investing based on maximum diversification principles may be a realistic way for active managers to achieve scalability and control risk exposures.
– A scalable investment process based on issuer selection can address the breadth of fixed-income markets.
The credit markets have evolved since the global financial crisis (GFC), with limited market liquidity provided by financial institutions. As a result, exchange-traded funds (ETFs) have emerged as an alternative source of liquidity. However, the high concentration among ETF providers and their trading algorithms have led to increased volatility and higher liquidity costs. This raises concerns about the liquidity expectation of ETFs.
Passive investing has also put pressure on active managers’ business models. The scalability of alpha generation is a challenge for large funds, as they allocate more risk to generating alpha than their passive counterparts. However, the largest funds don’t necessarily carry more specific risk than comparably sized ETFs.
Active managers need to adapt their alpha-generation skills to achieve scalability. It’s important to note that alpha generation may not be scalable, and the race for scale among active managers in response to low-cost ETF competition may be self-defeating.
Selecting the right manager with alpha-generating skills is a challenging task, as the probability is comparable to a random coin toss. This suggests that investors face challenges in identifying funds with the best alpha-generation skills.
Investors face concentration risks and increased liquidity premiums when investing in ETFs. Active managers, particularly large funds, face challenges in delivering alpha and demonstrate a convergence towards passive strategies. This raises questions about the extent to which active managers can operate in credit markets at scale.
Quantitatively driven credit investing based on maximum diversification principles may be the only realistic way for active managers to achieve ETF-like scalability. This approach allows investors to expose themselves to a wide set of risks and excess return drivers through issuer selection while controlling these exposures over time.
In conclusion, the credit markets have experienced changes since the GFC, with limited market liquidity provided by financial institutions. ETFs have emerged as an alternative source of liquidity, but their concentration and trading algorithms create volatility and higher liquidity costs. Passive investing has put pressure on active managers’ business models, and the scalability of alpha generation is a challenge for large funds. Investing in ETFs exposes investors to concentration risks and increased liquidity premiums, while active managers face challenges in delivering alpha. A quantitatively driven credit investing approach may be the key to achieving scalability for active managers.
