Home' Trinidad and Tobago Guardian : August 2nd 2015 Contents AUGUST 2 • 2015 www.guardian.co.tt BUSINESS GUARDIAN
MUTUAL FUNDS | SBG13
Imagine the bond market as a
crowded swimming pool,
except it s one where the water
level drops whenever someone
tries to leave. By the time you attempt
to get out, you re stuck at the bottom,
unable to exit because the ladder is
10 feet above your head.
Now you know what the bond mar-
ket is worried about. Bond fund man-
agers are increasingly talking about
the market s "liquidity," or how easy
it is to buy and sell bonds. Concerns
are rising that the day is approaching
when everyone will rush for the exits
at once and drain the market s liq-
uidity, perhaps after the Federal
Reserve begins raising interest rates.
"I think liquidity is misunderstood,
and I think it is often taken for grant-
ed," says Matt Freund, chief invest-
ment officer of USAA mutual funds.
"And the time to think about it is
before you need it."
When liquidity is abundant, anyone
who wants to sell a bond can easily
find a buyer. But when liquidity dries
up, buyers are scarce. At worst, none
are available, or they re willing to buy
only at fire-sale prices, and fewer
bonds than you were hoping to sell.
For investors in mutual funds and
exchange-traded funds, liquidity isn t
much of a concern. They can pull
their money from a bond fund at the
end of every day; or at any time during
the trading day if they re in an ETF.
But the story is different for fund
managers. They typically have some
cash in their portfolios to return to
shareholders who withdraw their
money. But if there is a surge in with-
drawals, managers could be forced to
sell bonds to raise more cash. And if
the market is full of others also looking
to sell, bond prices plummet.
Depressed prices mean that
investors who withdraw their cash
from bond funds when liquidity is
low may end up getting less than they
Facing the prospect of diminished
liquidity, some bond fund managers
are building up their cash holdings.
Not only does that give them a bigger
cushion to pay out to redeeming
shareholders, it also provides the
power to be a buyer during a sell-off
and take advantage of slashed prices.
Among other moves, some funds
are also keeping more than they oth-
erwise would in Treasurys, considered
the easiest-to-trade bonds.
To be sure, there s a cost for such
defensive moves: the lost income that
the funds would have made by holding
other types of bonds with higher
Plus, even Treasurys have had bouts
of volatility. In October, the yield on
the 10-year note plunged by more
than a quarter of a percent within
minutes, something that could typ-
ically take days or weeks. The yield
quickly recovered, but the steep, sud-
den move rattled investors.
Treasurys haven t had a shake-up
like that since, but liquidity in other
areas of the market is worsening.
"We re already beginning to see a
market where it gets very difficult to
sell securities in an efficient way," says
Jeffery Elswick, director of fixed
income at Frost Investment Advisors.
A year ago, when Elswick wanted
to sell some bonds, he would routinely
get back bids from at least 20 prospec-
tive buyers. "It s not uncommon now
to get two, three or four," he says.
"And one of those is so far out of the
market that it s not even like bidding."
Given the liquidity concerns,
Elswick has roughly a quarter of his
Frost Total Return Bond fund in Trea-
surys. "All else equal, we would own
five to 10 per cent, max," he says.
Several reasons are behind the liq-
uidity worries. Big Wall Street banks
used to step in as buyers during past
downturns but are now less willing.
Fund managers say it s because of
tighter regulations on banks risk-
Another worry is the impact of so
many dollars in the bond market mov-
ing in the same direction. Bonds have
been popular, and low interest rates
have pushed investors to take more
risk in search of extra yield. So money
that used to be in a money-market
account is now in a short-term bond
fund, while money that used to be
there is now in longer-term bond
funds. The threat is that when interest
rates rise, everyone will take a step
back down the risk ladder. All at the
The concerns mean it s important
to make sure you re in the right type
of bond fund.
For anyone who won t need the
money for five years, an intermedi-
ate-term bond fund may make sense.
"But if they re investing that tuition
payment or for that spring vacation,"
a money-market account or a short-
term certificate of deposit make more
sense, says USAA s Freund.
Otherwise the risk is too high that
when it comes time to withdraw,
interest rates may be moving higher
and bond prices falling due to forced
selling as other investors withdraw
"You will always be able to get out
of your bond mutual funds, you will
always be able to sell your ETFs," Fre-
und says. But the price you get will
depend on how liquid the market is.
Fund managers bulk up on cash,
as less liquid bond market looms
"You will always be able
to get out of your bond
mutual funds, you will
always be able to sell
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