The price of US junk bonds is a warning to investors


“Challenging the liquidity of a fund creates a major risk of. . . [a] “Snowball effect,” said a statement Tuesday from H2O Asset Management, the London-based fund manager hit by 8 billion euros in cash outflows after a Financial Times investigation.

Liquidity, broadly defined, refers to the ease of buying and selling an asset without significantly changing its price. If there is a lot of liquidity then it is easy to trade even in large sizes. If there is not a lot of liquidity, the reverse applies.

But the real difficulty is that liquidity is transient, notes Oleg Melentyev, strategist at Bank of America Merrill Lynch: there one minute, not there the next.

Consider the inflows and outflows of US high yield bond funds, an asset class that normally gives a good idea of ​​investor appetite for riskier, lower quality assets. BofA notes that between April 26 and June 7, investors withdrew $ 7.1 billion from these funds – a significant amount of money, but one that shouldn’t really disrupt the market, given that $ 10 billion in junk bond dollars change hands on average every day.

Yet during that time, the extra yield on top of U.S. Treasuries demanded by investors to hold junk debt rose by an eye-catching amount: from 3.7% to a peak of 4.8%. .

Then things turned around, helped by conciliatory signals from the US Federal Reserve. About $ 6.6 billion has since been reinvested in funds, while spreads on Treasuries have fallen back to 4.1%.

Observers will note that during this period fears of a global economic slowdown, spurred by an all-out trade war, increased before dissipating again. Nonetheless, BofA strategists have said there is no fundamental reason for junk bond prices to move as much as they have, and others agree.

In a more sustained liquidation, mutual funds offering daily redemptions to investors could be hit by a wave of cash outflows, similar to the H20, forcing them to divest their assets quickly. Without liquidity in the market, the fear is that it will exacerbate a rapid fall in prices.

Regulators have taken note. Three years ago, the Securities and Exchange Commission finalized the rules for funds to report on the liquidity of the assets they own, based on how quickly they expect to be able to sell them without significantly affecting them. significant market prices.

But the mini-panic over US junk bonds, combined with the drama surrounding H2O and other funds affected by withdrawals, has brought liquidity risk back to the forefront of investor concerns. Bank of England Governor Mark Carney said last month that funds that bought illiquid assets while giving investors quick access to their cash were “built on a lie.”

“When everyone is running for the exit, there will just be no liquidity and that will cause serious problems,” said John Dixon, high yield bond trader at Dinosaur Financial Group in New York.

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