The increasingly poor trading conditions for bonds now look to be sparking serious concern that a crisis is looming for funds that buy the asset class.
What these fears boil down to is the fact that most open-ended funds offer plentiful liquidity.
Investors can instruct a fund manager to return their money and the manager must then hand them cash pretty much there and then.
This ultra-liquid structure is designed to hold investments in similarly liquid assets. And at normal times assets like equities, bonds, funds and many derivatives are indeed highly liquid.
But sometimes that liquidity dries up. The last time this happened in a major way was when the property market tanked in the wake of the 2008 credit crunch, forcing property funds to adjust their pricings to prevent investors withdrawing their money.
The alternative would have been to sell off property assets at cripplingly low values, and that would have been extremely harmful for the funds’ remaining investors.
It would be worrying if today’s bond funds – some of which are astronomically big – were in a similar situation to the property funds back then.
Their assets are certainly not being traded that liquidly. At times, fund managers are today finding themselves unable to sell out of bonds at reasonable valuations, particularly in high yield.
If Greece collapses, or the US Fed suddenly embarks on an aggressive programme of monetary tightening, and the bond market enters a serious correction, investors will be queuing up to pull their money out. Much like with a run on a bank, these things of course generate their own vicious cycles. The more investors see other investors heading to the exit, the more they want to join in. Panic takes hold.
Is this going to happen on bond funds?
It seems that even bond fund managers now fear it might.
Aberdeen Asset Management boss Martin Gilbert last week told the Financial Times his firm had set up a $500bn (£315.3bn) credit line as a war chest to pay off investors if they start hitting the panic button.
Later in the week Amundi, the vast investment firm owned by Crédit Agricole, told the same title the bond markets could be the “epicentre of the next crisis”, calling for better regulation.
The UK fund industry has recently argued it is not the size of a bond fund that matters in determining whether it will become illiquid, it is the investments it makes. I hope that’s true.
If the bond fund crunch does come, the first signs will be outflows from the funds. Big outflows.
The savvy investor would be well advised to pull out ahead of the crowd.
John Kenchington is editor of Investment Adviser
