BoE Warns of Threat to Financial Markets From Potential Corporate Bond Sell Off – Investment Week
July 14, 2017 \
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Full Article: Investment Week
It found that redemptions worth 1% of the total net asset value of bond funds could result in European investment grade corporate bond spreads increasing by around 40bps, while a sell-off of 1.3% of assets could lead to a 70bps widening.
Comments
The Friday Newsletter has had numerous Articles of the Week that have highlighted the anecdotal evidence of decaying liquidity in the bond markets. The fact that the BOE has empirically developed a scenario where a drop in the value of derivatives of the bond market can have a multiplier effect impacting the broader market should serve notice to those who denied any decay because it didn’t fit their narrative. They used to claim that there’s no there, there. Well, there is.
Interesting article about BoE analysis but not sure what value this brings other than knowing that the BoE (and hopefully others) understand that yes, spreads widen when there are more sellers than buyers and spreads tighten when more buyers than sellers. Am I being too simplistic? This is the same for all markets so why be surprised that their analysis shows this for the corporate bond markets? Perhaps it is their effort to try and model events to put some meat behind this but historically modeling is nice but rarely accurate due to way too many moving pieces. I think… Read more »
“Suspending Redemptions”.
Now here is an interestingly bad solution. If some investment vehicles suspend redemptions and other market participants don’t have redemptions to suspend, what do you think the latter will do in times of volatility? Sit by idly and wait for the market to return to “normalcy”? Nah, hit every bid that those portfolios own. Ultimately, these vehicles and the bonds that they own will also have “redemption suspension risk”.
What will mom and pop investors learn about fixed income? That they, once again, will be left holding the bag while institutional investors take them to the hoop.
Here is the cliff notes to the paper. The corporate bond market will get seriously hammered if an event takes place that creates large redemptions. A few more thoughts though before you go. As Merlin points out, what market doesn’t get scorched in this scenario? It seems the BOE is saying that given changing market market dynamics with the same market structure, the beating for credit today will be of a larger proportion. Market doubles in size, top buy size firms are enormous. The dealers have “pulled back” (or not kept up?), and capital is more expensive. This growing imbalance… Read more »
Believe it or not, there’s a valid question under all these Armageddon-style articles about pending doom in corporate bond funds. And the question is: Are corporate bonds still appropriate for an open-end fund structure that offers daily liquidity? The less liquid the benchmark, the bigger the risk that a corporate fund enters the Third Avenue downward spiral: get redemptions, sell your most liquid stuff to meet redemptions (negatively impacting performance), get more redemptions, run out of liquid stuff to sell, shut down. Yes, redemptions lead to wider spreads and liquidity/existential risks, but any fund manager that’s not living under a… Read more »
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