Accessing the most liquid parts of the credit markets requires skill, experience and use of the latest technology. It also requires flexibility, which I believe stems from a balanced, diversified portfolio. Only by not getting tempted to follow the herd into more illiquid parts of the market, can the corporate bond investor stay balanced. 
We like to take a balanced approach to risk. This means not being positioned at the extremes. Staying balanced allows us to take advantage of all the possible opportunities that present themselves. We apply this balanced approach to all aspects of a portfolio, including companies, sectors, geographic regions and credit ratings bands. What a balanced approach gives us above all else is flexibility. And flexibility is often precisely what is needed in order to ensure that a portfolio is at its most liquid at all times.
Liquidity management
Liquidity should also be balanced. Whether it is or not often depends on the mindset of a portfolio manager. Those who run their funds in a rigid way, perhaps preferring to use illiquid bonds as a way of driving alpha, or with large overweights to BBB-rated bonds, are opening themselves up to bouts of market illiquidity and the danger of getting trapped.
An essential part of running a balanced strategy is investing with liquidity in mind. It is true that sterling credit markets are less liquid than those in euros, and particularly those in US dollars, and this creates challenges about which investors should not be complacent. That is why we seek out diversification of liquidity rather than becoming transfixed by the additional carry of illiquid names and BBBs. This requires an appreciation of the mechanics of the broader market outside the bonds that retail funds tend to invest in, and an understanding of why other market participants buy what they do. A good example is single A-rated bonds, which are the “sweet spot” for huge UK life insurance companies because they are the most capital efficient.
Another example is the very strong technicals enjoyed at present by contingent capital bonds (CoCos). Another is the positive implications of changes to Libor and bank ring-fencing for the liquidity of the very high-quality short end of the credit market.
Recognising that these parts of the market have greater liquidity requires both skill and experience. It can be helped nowadays by new technology that reinforces what makes logical, fundamental sense from a practical perspective. It highlights for example how bonds become less liquid with age (which is why we much prefer to invest in newer bonds), or are more liquid and trade in much greater size higher up the ratings bands (hence we prefer a strong quality bias compared to most retail funds).
In summary, accessing liquidity requires skill, experience and the ability to diversify. That is why we do not follow the herd into uncomfortably large positions in illiquid bonds, or into the lower reaches of the investment-grade credit market, such as BBBs. Instead, we look for genuine diversification and balance from all perspectives, including liquidity – a dimension so often overlooked by sterling corporate bond fund managers.
So stay balanced, and don’t follow the BBB herd.
Lloyd Harris is manager of the Merian Corporate Bond fund. The views expressed above are his own and should not be taken as investment advice.