Several of Australia’s largest asset managers have warned of evaporating liquidity in fixed income markets including high-grade sovereign bonds, forcing them to pass the higher spread onto their investors.
A Morningstar report found that that in the span of a few days in March, both passive and active managers including Vanguard, Blackrock, AMP Capital, PIMCO, Perpetual and Macquarie had significantly raised the sell spreads on their bond funds as it became harder for them to trade the underlying assets.
“The current circumstances are almost without precedent,” said Tim Wong, director of manager research at Morningstar. “This period has thrown a curve ball on conventional wisdom about the liquidity of even the highest grade bonds and portfolios that invest in them.”
The crisis in the bond market triggered by the outbreak of the coronavirus comes despite the best efforts of central banks to calm investors by injecting liquidity into the system. The US Federal Reserve has pledged to make its treasury bond-buying program open-ended, while the Reserve Bank of Australia has already bought $9 billion in government bonds, after launching its quantitative easing program for the first time last week.
UK-based fund manager Schroders said that liquidity on Australian government and semi-government bonds had dried up so significantly that the bid/ask spread on the securities was up to 20 times wider than previously, according to Morningstar.
Raising cash
UniSuper’s investment chief John Pearce said one reason for the unusual moves in the bond market was because some investors that needed to raise cash were offloading fixed income rather than sell shares at such depressed prices in an illiquid market. The Australian share market has fallen more than 35 per cent since the peak in February.
“There are other technical factors,” he said in an update to members. “But the bottom line is that bond prices have been falling, and this has resulted in negative returns for an asset class that should be outperforming in a crisis.”
Jeremy Cooper, chair of retirement income at Challenger, said in an interview earlier this week that managing illiquid investment was a key issue for superannuation funds like corporate bonds which he said many would like to exit but can’t because there was no market to do so.
“It’s unclear how much liquidity the super funds currently have,” Cooper said. “There will be more demand for realising assets when it is a bad time to be selling anything right across the board.”
Superannuation funds had around 12 per cent on average allocated to Australian fixed interest assets and 9 per cent to international fixed interest, according to the prudential regulator’s latest publicly available statistics. That compares to an average 47 per cent allocation to equities both in Australia and offshore.
Morningstar’s Wong said that the drying up of liquidity in fixed income was particularly problematic for those needing to rebalance a portfolio into another asset class. For automatic asset allocation rebalancing, the significant falls in equity holdings were likely to be re-weighted by selling fixed interest exposures.
“Getting the money out is costly,” Wong said in an interview. “The underlying bonds that are held in these portfolios are trading in very erratic fashion, spreads are widening making it more difficult for fund managers to liquidate the holdings at fair value.”
The Morningstar report showed that for core Australian bond strategies, AMP Capital’s bond fund now levied a 0.9 per cent sell spread, up from 0.1 per cent previously. While among global strategies, a Macquarie fund had applied a new sell spread of 1.24 per cent, up from 0.080 per cent previously which was also significantly higher than most of its peers.
“The imposition of very high sell spreads makes this very costly, to the extent that it raises questions over whether investors should rebalance their asset allocation at all,” said Wong. “Weighing the heightened costs of redeeming from these funds against the potential return from shifting into the chosen asset class is essential.”
