Red lights are flashing over bond markets as fears mount that liquidity will evaporate when interest rates rise.
Nearly all bond sectors have made losses this year, including global and emerging market bonds, corporate bonds and UK government gilts, according to Investment Association data, which shows the average bond fund’s return.
With this dismal performance already eating into investor returns, bondholders may sell out en masse when interest rates rise – as hikes will cut the already-meagre returns on bonds. “I am very, very confident this is going to happen when rates start to rise. There is going to be a massive sell off,” says Haig Bathgate of fund manager Turcan Connell.
Some experts are suggesting investors sell out of bond positions now, as there is simply not enough liquidity in bond markets to support mass redemptions. Pre-crisis investment banks traded vast amounts of bonds daily, which kept the sector liquid, but nearly all have withdrawn from trading them.
Bank of England governor Mark Carney is believed to have been meeting privately with 135 fund management groups over how they plan to deal with investors rushing for the exit. He has criticised fund managers for “taking liquidity for granted and crowding into trades”.
So far this year, the only parts of the bond market to eke out a return are strategic bonds with a 0.9 per cent return – although after fund fees investors may well have made losses – and high yield, with a 2.72 per cent return.