Q&A: bond rout prompts fresh liquidity fears

A rout in government debt markets this week revived concerns that if a big sell-off takes place in corporate and high-yield bonds, liquidity problems could set in, making it difficult to sell or even identify the correct price for some securities.

Bill Gross, the influential US bond investor, recently warned again of a looming end to the long-term bull market in stocks and bonds; he also tweeted that there was "no liquidity in bond markets".

Such concerns have already pushed many investors into strategic bond funds, which promise the flexibility to seek performance and liquidity in different categories of fixed income globally.

But fund managers including James Foster, of Artemis, believe not enough investors are aware of the potential risks.

What exactly is the problem?

Bonds have traditionally been regarded as the "safe" and stable part of an overall investment portfolio.

But since the financial crisis, banks have cut back dramatically on their own "proprietary" bond trading, which had previously helped to keep markets running smoothly. Funds now hold far more of the bonds in issue.

As a result, sellers of bonds, which are not traded on a central exchange like shares, could find it harder to locate buyers.

That could prove a serious problem if many fund investors decide to exit at the same time - something that might happen as interest rates rise, for example. Price volatility might also rise, and many investors could be faced with losses.

What happens next?

There's a risk that some funds might have to prevent investors from withdrawing their money for a period of time.

"Pretty much all funds now have the ability to restrict redemptions in the event of liquidity problems, and this is a real risk in the bond fund sector," says Brian Dennehy, managing director of Fundexpert.co.uk.

If your investment horizons are long, this may not be as much of a concern, but Mr Dennehy warns: "If you think you will need to sell the fund or part of the fund at some point in the next five years or so, you need to be comfortable that you're going to be able to sell the fund."

What are fund managers doing about it?

About 60 per cent of asset managers have been buying more liquid assets such as gilts - although these come with very low returns, so performance will be hit. Others have increased their cash holdings, likewise limiting returns, according to Royal Bank of Scotland data.

The tabular content relating to this article is not available to view. Apologies in advance for the inconvenience caused.

"Owning short-dated bonds is the most powerful insurance there is," says Mr Foster.

Darius McDermott, managing director at Chelsea Financial Services, notes that Axa's Sterling Credit Short Duration Bond fund is designed so that about a quarter of the fund's holdings mature each year.

Are strategic bond funds the answer?

Funds such as M&G's Optimal Income have attracted billions in inflows over the past year, but not all strategic bond funds are the same.

"Some prioritise income generation by taking more risk, through investing a large portion of assets in subinvestment grade bonds, for example," says Tom Stevenson of Fidelity Personal Investing. These funds may offer more volatile returns than a traditional high-quality bond fund and may be more correlated with equities, he says.

"Others aim to deliver returns that provide a balance of income, low volatility and low correlation to equities."

And some strategic bond funds, especially large ones, could still be vulnerable to liquidity issues, Mr McDermott says.

Should I even own bonds?

Holding bonds can offer benefits, including damping the volatility of equities in a portfolio, says Jason Butler, chartered financial planner at Bloomsbury Wealth.

However, he warns that returns from bond markets may not be high enough for the levels of risk that investors are taking on.

But Mr Stevenson says that if the risk-return trade-off and time horizons are right, bond funds - including conventional corporate bond funds - can offer a source of income and diversification within a portfolio.

"Talk to your adviser about why you are invested in bonds - it might serve as a good reminder to yourself and [clarify] whether you are willing to stay invested even if there are problems in the short term," says Mr McDermott.

© The Financial Times Limited 2015. All rights reserved.
FT and Financial Times are trademarks of the Financial Times Ltd.
Not to be redistributed, copied or modified in any way.
Euro2day.gr is solely responsible for providing this translation and the Financial Times Limited does not accept any liability for the accuracy or quality of the translation