Share “What happens to bonds when everyone aims...”

What happens to bonds when everyone aims to sell?

Published on NewsOK Modified: August 14, 2014 at 3:25 pm •  Published: August 14, 2014
Advertisement

NEW YORK (AP) — If bonds start to tumble, should I sell my bond mutual fund?

It's a question investors are asking as expectations rise for a more volatile bond market. But a better question may be: How difficult will it be for my fund manager to sell?

Worries are increasing that some managers will have a tough time finding buyers for their bonds if a flood of investors tries to pull out of their funds at the same time. It's a concept called liquidity, and a lack of it can accelerate losses for bonds when prices are falling, at least in the short term. It would likely have less effect on fund investors willing to hold on through the volatility than those who sell amid a storm. But it's another risk that all bond fund investors need to consider.

The worries partially stem from new regulations that have led to banks holding fewer bonds on their balance sheets. Previously, banks' willingness to hold inventories of bonds offered a buffer when sellers in the market outnumbered buyers. Inventories of investment-grade and high-yield bonds at Wall Street banks and other primary dealers are now just 20 percent of where they were in 2007, according to State Street Global Advisors.

The areas of the market most likely to be hurt by the liquidity concerns include corporate bonds, particularly high-yield bonds that are issued by companies with weak credit ratings, says Dan Farley, chief investment officer of the investment solutions group at State Street Global Advisors. Treasurys, the largest sector of the bond market, aren't a source of concern.

IT'S HAPPENED BEFORE.

Some bond fund investors are already familiar with the phenomenon, such as those focused on bonds issued by cities and other local governments.

Several times in the last six years, fear has pushed investors to rush for the exits out of municipal-bond mutual funds. Managers typically keep a portion of their funds' portfolios in cash, so they have some ready for departing investors. But when a flood of sell orders converge, it forces managers to sell bonds to raise more cash.

In past periods of low liquidity, when managers went looking for buyers for their muni bonds, they often found many others also looking to sell. That caused municipal bond prices to tumble, which further frightened fund investors, leading them to pull yet more money, and fueled even more forced selling.

Last year, the trigger was worries about rising interest rates and the creditworthiness of Puerto Rico and other municipal borrowers. Investors began withdrawing their money from muni funds in the spring, and the largest category of municipal-bond funds lost 3.1 percent during the second quarter, according to Morningstar.

Continue reading this story on the...