7th June 2013
Worries over liquidity levels in corporate bond markets have been rumbling for some time. Some bond fund managers have adjusted their strategy amid liquidity fears while multi-managers are also worried. Investment journalist Cherry Reynard surveys developments in the last year about a growing concern and what bond managers are doing about it.
While bond markets remained buoyant these concerns were largely theoretical. However, bond markets have started to turn down, quite drastically in the case of the US treasury market, and therefore concerns over liquidity may start to become a reality.
Tom Becket, chief investment officer of Psigma sounded the alarm on Mindful Money, saying he was ‘extremely worried about some of the behemoth corporate bond funds, which have grown to a huge swollen size and might not be able to provide the liquidity that investors expect, were the sentiment towards the asset class to change quickly.’
A number of managers within the sector have also raised concerns. On fund analysis website Trustnet, Stephen Snowden, manager of the Kames Investment Grade Bond fund, says that the lack of new issuance in the market means that managers running very large portfolios will not be able to liquidate their assets quickly in the event of a sell-off in corporate bond markets.
Equally, Becket is not the first multi-manager to act on concerns over corporate bonds – John Chatfeild-Roberts, chief investment officer at Jupiter, sold out of the M&G Strategic Corporate bond fund in February of this year, though ostensibly on inflation considerations as FtAdviser.com reported. The bond managers themselves have raised concerns over liquidity. Phil Milburn, manager of the Kames High Yield Bond fund, has been honest about the liquidity problems faced by bond managers, and a year ago announced that the fund would be capped at £2bn to manage liquidity issues as trade website Investment Week reported at the time. M&G also acted to stem inflows into Richard Woolnough’s suite of funds.
Until recently this was a relatively rarefied debate among bond fund managers, but there has now been a substantial sell-off in the US treasury markets as they have started to anticipate the end of quantitative easing. This is likely to spread to corporate bond markets and may make a previously theoretical problem a new reality. Is it a problem for investors?
M&G said in December 2012 on its own BondVigilantes website that it did not consider the liquidity problems particularly pressing. Manager Richard Woolnough said that while it is clear that the ability of investment banks to provide liquidity in bond markets has diminished, other intermediaries have come into the market to provide liquidity. Borrowers are now using the corporate bond markets for funding rather than the banks and issuance remains relatively high. S&P recently reported that companies raised $326bn in new corporate debt in April, bringing the total since the start of the year to $1.2bn globally – this is the second highest four month total on record.
Christine Johnson, manager of the Old Mutual Corporate Bond fund, is also confident that a potential crisis in the corporate bond market is, as yet, unlikely to originate from within the corporate bond market itself: “External factors may buffet valuations somewhat but for now the ‘fragility’ factor remains fairly low.”
However, some of the larger managers do seem to be nervous about the problem and are taking steps to address it. For example, Ian Spreadbury has recently broadened the remit on his Fidelity £3.4bn Moneybuilder Income fund FtAdviser.com, in order to help him manage liquidity problems.
Chris Sexton, investment director at Saunderson House, has moved into absolute return bond funds in response to these problems. These funds currently have little exposure to interest rate risk and should be protected in the event of a change in interest rate direction. However, he does not believe that there will be dramatic problems in the corporate bond market: “Everyone is thinking about it and the market usually adjusts ahead of time. There will be no earthquake, though there may be tremors along the way.”
He believes investors are still risk-averse and many will use higher bond yields as a buying opportunity. Therefore any move higher in yields is likely to be incremental, rather than a sudden sell-off. He says: “Any ‘great rotation’ will probably happen slowly.”
Brian Dennehy, managing director of Dennehy, Weller & Co, says: “Liquidity is very poor in the corporate bond market, so price moves will certainly be exaggerated once bonds take a clearer turn for the worse. Assume that May was a shot across the bows of corporate bond investors (whether via funds or individual issues). I’m not sure this is just an issue for bigger funds – in fact a number of the bigger funds seem to be anticipating the issue by having solid amounts in cash and gilts, so they can more than adequately cope with redemptions.
“It may not be a rout, but does the income and capital return potential from corporate bonds justify the risk taken? Corporate bonds have had a strong run and are unlikely to move significantly higher from here. Equally, the income available has diminished. The balance of risk and return has moved against the sector.”