The effect of shrinking investment banks’ balance sheet on the liquidity of U.S. fixed income markets has been broadly discussed for the past several years. Events such as the high yield outflow this past July and August has been one of the main reasons why the Federal Reserve (Fed) has tossed out the idea of putting “gates” or redemption fees on mutual funds. This begs the question, what happens to the liquidity risk when huge outflows hit one of the largest mutual funds in the world?
Indeed, the recent departure of legendary bond investor Bill Gross from PIMCO has sparked liquidity fears and has investors wondering what the impact will be on fixed income markets. Billions have already left PIMCO since Mr. Gross accepted his new post at Janus Capital Group, and many consultants are concerned about the potential liquidity problems that could emerge as PIMCO sells its most liquid assets to meet redemptions, which could cause its funds to become less liquid over time. For many investors, the big question now is whether there will be a fire sale from PIMCO funds, with investors heading for the exits. I think there will be redemptions — some large scale ones at that – but they’ll be over a period of time.
Nevertheless, in this situation, you have to ask yourself: do you want to be the last person in the fund or should you get out now. If so, where do you allocate the money in a period of increased volatility? And even those investors not directly invested in PIMCO strategies need to keep tabs on what the assets at PIMCO are doing – what is being held, and what is being sold – because that has potential to impact the liquidity of similar bonds held by other managers.
We’re already expecting financial-market volatility with the Fed’s tapering of bond and mortgage purchases, as it winds down its quantitative easing program. But now the Fed and the SEC are faced with the risk of one of the largest mutual fund companies in the world suffering such significant outflows. Let’s face it; no one expected this to be the catalyst for a wave of selling to test the investment bank balance sheets (thank you Dodd Frank). But now, however, consultants are provided with a huge opportunity to direct the money in motion in the U.S. fixed income marketplace.
Similarly, I believe that the money in motion because of Mr. Gross’ departure from PIMCO, coupled with less liquidity, will result in fixed income managers who not only were able to use this turbulence to help their investors, but also find new buyers of their fixed income strategies and gain better long-term outcomes for their clients.
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