In a previous post, I wrote about the regulatory scrutiny being applied to the liquidity ofopen-ended funds. As the deadline for compliance to SEC rule 22e-4 draws nearer, more and more managers are working through the details of how to comply. In the fixed income markets, judging liquidity can be a complex issue.

Assessing liquidity for fixed income instruments is anything but straightforward; it's a mosaic comprised of multiple factors that exist in a dynamic ecosystem. When people think of liquidity they often think of trading. But trade activity alone is insufficient. For example, a firm might own an entire municipal bond issue. They sit on an attractive piece of paper and have no interest in selling it. As such, there is no reported trade data for that bond. Additionally, no dealers quote the issue. Just because you don't see trade activity for a name doesn't necessarily mean the paper is illiquid. If the firm needs to exit that position, they still can put it out for bid and exit the position in relatively short order.

And it isn't always a movement of the price that indicates liquidity; it's also the time it takes to trade it. A trader will tell you that it takes longer to get a trade done, or she may have to break up a position into multiple trades. Whereas she used to be able to find a buyer in minutes, it now takes her hours. A manager may have assets at both ends of the spectrum in a single portfolio. For example, you have Treasuries that you can trade instantaneously; but if you are sitting on an esoteric instrument, it may take a while to find a buyer that's interested in taking on that kind of risk.

Assessing liquidity requires deciphering market context of quotes and discerning the difference between an indication and an executable level. A dealer provides a view at what level he or she thinks an instrument may trade at - an indication; but you get a better sense of the executable market if the run includes size or the dealer is actively making markets.

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This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.