Fears that bond funds could succumb to a liquidity crisis have begun to take hold, with one research house becoming the first to start suspending fund ratings over these concerns.
Research firm Fundhouse said investors faced potentially huge losses on illiquid holdings if the recent sell-off in fixed income accelerated.
It comes after Aberdeen Asset Management’s chief executive Martin Gilbert said last week in the Financial Times that his firm had built up a $500bn (£315.3bn) credit line in case of a full-blown fund liquidity crisis.
Fundhouse’s chief executive, Rory Maguire, said some bond funds could struggle to offer daily liquidity to their investors because their underlying holdings might take months to sell in the event of a market rout.
The research house’s warning comes after Bank of England governor Mark Carney sounded the alarm about market liquidity, which he said posed “a clear risk to financial stability”.
Mr Carney highlighted those “investment funds that offer daily liquidity while investing in securities that only appear liquid”, and said regulators should be looking closely at such vehicles.
Mr Maguire said such an “asset liability mismatch” could exist within many strategic bond and multi-asset income funds.
His firm has suspended ratings on three funds in the strategic bond and multi-asset sectors. Fundhouse is also holding off on rating a number of other large bond funds over concerns about illiquid holdings.
He said this had been the case for some time but had not been an issue because there had always been “more buyers than sellers”, so there had always been someone waiting to snap up bonds if fund managers needed to sell.
But Mr Maguire said this trend may be about to end because “outflows seem to be starting”, which could turn managers into “a collective of forced sellers”, which has not been seen since the financial crisis.
Analysis from Bank of America Merrill Lynch found last week that dollar-denominated bond funds suffered their largest outflows for two years as investors rushed to withdraw $10.3bn.
The sell-off was spread across the credit spectrum, with investors abandoning government bonds, investment-grade credit and high-yield bonds.
If the sell-off becomes extended, Mr Maguire has warned of a liquidity crunch, particularly within high yield, an area many fixed income managers have built up substantial positions in due to its superior return profile in recent years.
Mr Maguire said he had spoken to managers who had admitted they “struggle to sell modest-to-high volumes of high-yield bonds (without a price hair cut), unless they have months to do it”.
Why Bill Gross’ Pimco exit was not a true test of bond market liquidity
When legendary bond investor Bill Gross quit Pimco, many thought the scale of outflows from his $221bn (£139.5bn) Total Return fund would rock the markets.
However, the lack of any market chaos, in spite of more than $100bn in outflows, seems to have convinced some investors that the issue of bond market liquidity in a sell-off has been overblown.
But Fundhouse’s Rory Maguire said this view was misguided because the Pimco outflows were “compensated for by net inflows in the industry”.
“The bonds simply shifted to other fund managers who were net buyers,” he said. “The market has not been tested in a ‘net outflow’ environment, when most asset managers are net sellers.”
