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Despite Resilience, Investors Warn About Liquidity

Fund managers say risk remains in bond funds, despite steps to ease panic selling initiated after the global financial crisis

Investment managers have warned that some bond funds could still struggle to meet redemption requests in the event of a sustained period of outflows, despite efforts since the 2008-09 global financial crisis to make the industry more resilient.

The warning comes as the Bank of England prepares to release a report, “Simulating Stress Across the Financial System,” which will document how it plans to assess risks in the European corporate bond market in future studies.

Since the financial crisis, bond fund managers have integrated more traders into their investment teams, increased liquidity monitoring, set up emergency borrowing facilities, and enhanced the proportion of liquid assets in portfolios to add protection. However, speaking on the eve of the Bank of England report, fund managers said that it is right for regulators to examine the sector more closely.

In an interview, Chris Bowie, a partner at London fixed-income manager TwentyFour Asset Management, said the run on real-estate funds witnessed after the United Kingdom voted to leave the European Union in June 2016, showed just how widespread illiquidity can lead to panic among investors.

Bowie was referring to an episode in July after the Brexit vote, when U.K. funds holding around £15 billion ($19.28 billion) in assets at Aviva, Canada Life, Columbia Threadneedle, Henderson Global Investors, M&G, and Standard Life placed a temporary ban on withdrawals after a surge of redemption requests.

Bowie said that it is perfectly plausible that the same could happen in the corporate bond market, given the right economic circumstances. “If you look at what happened to property funds in the last year, I think liquidity is a big issue,” he said. “There are definitely some open-ended funds that might struggle if we have a big liquidity meltdown.”

Bowie’s peers echoed his concern.

David Riley, the head of credit strategy at Bluebay Asset Management, agreed that it is a subject that deserves further attention from regulatory authorities.

He told Institutional Investor: “We do think there is a tail risk associated with any liquidity mismatch, which regulators need to think about in [terms of] future regulation of the financial system.” Riley added that further attention could be given to how fund managers have planned for adverse events.

Fund managers say that two events on the horizon in Europe could initiate a selloff in bonds. The first is a reduction in the €60 billion ($68.67 billion) of securities that the European Central Bank buys every month as part of its quantitative-easing support for the bond market. Bowie said that if the ECB rushed to reduce those purchases, investors could dump bonds in favor of equities or cash. On Tuesday, ECB member and Bank of France governor Villeroy de Galhau told Bloomberg that any such decision would not be taken at least until the fall.

The second event is the Italian general election, which has to occur before May 20, 2018. Bond investors would not favor a strong performance by the eurosceptic party, the Five Star Movement, which would like to see Italy leave the European Union. That, too, might lead to panicked selling.

Despite these relatively near-term events, fund managers maintain that liquidity levels are sufficient to weather any short-term run of withdrawals.Morgane Delledonne, a fixed-income strategist with ETF Securities, said: “Asset managers should have higher capital buffers. So far, from what I have seen, I don’t have any kind of quantitative measures that can prove there is a lack of liquidity.”

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