Investors should not fear a liquidity crisis in fixed income markets in the near term, according to Andrew Chief investment officer of Fidelity fixed income.
A seemingly infinite search for income has driven bond yields ever lower and pushed many fund managers, as well as other investors, into higher risk parts of the fixed income market of late.
This, along with investment banks stepping away from their historic ‘market-making’ role thanks to tighter regulatory conditions, has caused many commentators to ramp up their concern that should the market dry up, a crash could prompt a devastating era for investors.
These concerns are particularly prominent at the moment given the US is likely to raise interest rates next week for the first time since the global financial crisis.
According to FE Analytics, the fixed income market as measured by the IBOXX Markit Overall index and the average return in the IA Sterling Strategic Bond sector is up year to date.
However, this belies the fact that a swift rally in the early months of the year push the numbers up sufficiently to mask the markets trend downwards since April or so.
Performance of indices since 10 April 2015
Source: FE Analytics
Most recently fixed Income funds saw a net retail inflow for the first time in six months, with net retail sales of £109 million, compared to an outflow of £515 million, according to data from the Investment Association.
Wells, who has previously said a major challenge is that the areas of the fixed income market where there is the most value is also the most illiquid, thinks the current conditions are a good opportunity for investors over the longer term.
“The things that hurt you the most are the things you don’t see coming and we have all seen this one coming and, boy, have we done a lot to prepare for it. You can’t escape the fact that banks have shrunk their balance sheets and put less money into trading risk capital and so liquidity is not what it once was,” he said.
“We are very aware of that but we don’t see it as the biggest issue at the moment. In credit in particular, where you pay a premium over government bonds for two reasons the credit risk and illiquidity risk.”
“For those investors who are in it for the long run, there is a huge opportunity to harness that and make money but if you are there for the short term the you have to be very careful because liquidity wasn’t great a short while ago and it is worse now.”
The IA UK Gilts sector has seen the best return of the major bond peer groups in the Investment Association universe in 2015 with a return of 1.26 per cent from the average fund in the sector, almost double that of the IA Sterling Corporate Bond.
Performance of sectors in 2015
Source: FE Analytics
However, Kames Capital’s Adrian Hull warns that liquidity issues could be a very real risk to investors in the future.
“There is no doubt that liquidity is poor. Andrew Tyrie MP has raised this issue most recently with Bank of England governor Mark Carney - although both the BoE and FCA have already raised concerns that it is an industry wide issue,” he said.
“In the event of a liquidity crisis there is obvious concern that vulnerable consumers will be exposed to a bond market sell-off, as post the economic crisis low interest rates have encouraged a wider consumer audience to consider corporate bonds in their search for income who would not previously have invested in them.”
However, Chelsea’s Darius McDermott says that it is only in the higher yielding credit space that investors can expect a decent return.
“I suspect the only way to make any kind of return from bonds is to look for a decent yield to cushion you from any price falls. That means corporate bonds, both investment grade and high yield,” he said.
FE Alpha Manager Ian Spreadbury who runs a host of Fidelity’s bond funds including the £1.5bn Fidelity Strategic Bond fund is one such manager loading up on credit.
“Investment grade corporates, in particular, are attractively valued with spreads almost pricing in recession type levels.”
However, he thinks default rates are likely to pick up due to a ramp up in corporate leverage of late as companies have taken advantage of low yields to finance share buy-backs mergers and acquisitions activity.
“This reinforces the need to remain selective in my view – even if there is a good chance that spreads could tighten from current levels. Striking the right balance between yield and liquidity will also remain extremely important in the coming year.”
Performance of fund vs sector in 2015
Source: FE Analytics
Fidelity Strategic Bond has had its toughest relative year for at least the past decade with a small loss of less one percentage point putting it in the bottom quartile in the sector in contrast to its strong 2014 performance.