The Bank of England has warned investors of risks lurking in the bond market, in a speech to delegates of London Business School’s Asset Management Conference on Thursday (26 April).
Alex Brazier, executive director for Financial Stability Strategy and Risk at the Bank of England, said investors were increasingly happy to take risks for lower rewards than they had previously and urged them to mindful of lurking risks from liquidity, interest rate volatility and the use of leverage.
“Since the crisis, funds have flowed into open-ended investment funds that make no promise of redemption value,” he said.
“These funds are increasingly invested in less liquid assets while continuing to offer next day redemption to investors.
“The share of corporate bonds held in open-ended funds in the UK and the Euro Area has increased by 70 per cent since the crisis. Their structure may create incentives for their investors to redeem in [times of] stress, forcing fire sales of illiquid assets.”
Mr Brazier said the Bank of England had been investing in “simulation models” to test the scenarios most likely to cause market turbulence.
“Our work here explores the depths of how open-ended funds, hedge funds, dealers, insurance companies, unit-linked funds and pension funds might, through responding separately to their incentives and constraints, amplify market shocks.”
Advisers acknowledged the industry’s unparalleled search for yield in recent years and said that the Bank’s note of caution was important.
“Investors who are in bond funds need to be careful,” said David Scott, an adviser at Leeds-based Andrews Gwynne.
“Income seekers have gone anywhere and everywhere for yield. Our view is that economies around the world are slowing quickly and a downturn could see a lot of corporate debt downgraded to junk, meaning that the investment funds would have to sell it.”
Mr Scott said he saw similar warning signs in the credit market now, to those witnessed prior to the credit crisis, adding that the Euro Libor interest rate had “gone flying up” recently.
“That tells you all is not well in the world. The credit crisis has never really gone away. It was simply masked by Central Bankers printing money.”
Patrick Connolly, a spokesman for Bath-based advisory group Chase de Vere, said fixed interest has progressively become a lot more expensive since the credit crunch, with investors happy to accept a lower return for their risk.
“We are now in an environment where many fixed interest assets look expensive and there is a big question mark as to whether fixed interest will provide the security that advisers use it for. That is something we have been worried for some time.”
