“This raises the controversial issue as to whether fixed interest funds are actually entirely appropriate to be daily traded vehicles.
“Clearly the vast majority of funds are daily traded and this is fine when the underlying assets have strong liquidity. But the issue with bonds is that at times of stress they lose their liquidity.”
According to the latest stats from the Investment Association, fixed income funds saw a net outflow of £515m in September – the highest outflow for this asset class since June 2013 – though it is a continuation of a long-term trend.
Hughes’ argument centres mainly around high-yield funds, adding that at this end of the credit spectrum these funds would be better suited to weekly or even monthly dealing to give the managers time to raise liquidity in an orderly fashion rather than having to potentially sell assets at a sub-optimal price, which is not in the interests of any investors.
“There is a risk that we are about to enter a prolonged fixed interest bear market which combined with the exit of the greatest financial experiment in history has the potential to cause major market disruption,” he says.
“With the risk that many investors run towards the exit door at the same time, the chances of a liquidity squeeze are very real.”
You can read more on fixed income illiquidity in the forthcoming December edition of Portfolio Adviser, out soon.
