Liquidity drying up across markets, fueling big swings -Capstone

NEW YORK, June 18 (Reuters) - Deteriorating liquidity across markets is exacerbating swings in a wide range of assets, according to alternative investment management firm Capstone.

Market liquidity, or the ease with which investors can buy or sell securities without affecting their price, has been in a downward spiral in recent years, Capstone said in a research paper.

For instance, liquidity in S&P e-mini futures, one of the most popular trading instruments in the world, is down 95% from its 2008 levels, the firm’s research showed.

“Market liquidity has started to behave like sand. The tighter you try to grip sand, the more it slips through your fingers,” Rishabh Bhandari, Capstone senior portfolio manager and the paper’s author, said in an interview.

The New York-based fund manages $9 billion and provides services that aim to protect portfolios from market volatility.

The firm points to several events in which scant liquidity exacerbated market swings, including the so-called taper tantrum in 2013, the aftermath of the 2016 Brexit vote and U.S. presidential elections and the market swings in the wake of the COVID-19 pandemic last year.

Market depth is particularly poor during turbulent times, such as during the COVID-19-fueled market sell-off in March 2020, when trading liquidity shrank to a record low, the paper showed.

Since 1990, there have been 129 days when the Cboe Volatility Index - dubbed “Wall Street’s fear gauge” - logged a 1-day move of more than 5 points, with more than half of them occurring after 2008, a Reuters analysis showed.

The dearth of liquidity extends throughout asset classes, with U.S. Treasury futures, European equity index futures and Japan’s Nikkei 225 futures all affected, according to the paper, to be published on the Capstone website next week.

Increased regulations curtailing large broker-dealers’ capacity to take risk, the rise of rules-based investing and automated market-making have all played a part in reducing liquidity, according to Capstone.

Given the tight relationship between liquidity and volatility, investors’ need to adapt to the changed trading conditions is more important than ever, Bhandari said.

The firm, which specializes in global derivatives and volatility trading, has seen an uptick in demand for hedges, he noted. (Reporting by Saqib Iqbal Ahmed; Editing by Dan Grebler)