There is a potentially huge risk lying in the bond market, according to ratings agency Fitch, and it centers on the mismatch caused by funds offering daily liquidity but holding securities which may be less liquid.
As the multi-week sell-off in U.S., U.K. and German sovereign bond markets gathers momentum, a Fitch report published Monday highlights the risks to the value of assets held in funds should there be a stampede for the door by investors.
According to its authors, Manuel Arrive and Alastair Sewell, both Senior Director at Fitch: "Drawdowns resulting from fire sales in illiquid markets increasingly put fund capital at risk, as bond carry returns have become insufficient to offset volatility."
The Fitch analysts call into question the suitability of offering daily liquidity for as many as 90 percent of UCITS (mutual funds based in the European Union) bond funds.
The report also raises a red flag over portfolio managers, who are attempting to diminish the threat of liquidity issues, having to adapt investing strategies in ways which could affect the return potential of their funds. Among the methods cited by Fitch, it is suggested some managers may be being forced to take smaller positions and over-diversify holdings as well as retain a higher balance of cash and liquid securities.