18th July 2014
Investors in corporate bonds may face a shock as they try and exit the asset class due to liquidity ‘concerns’.
Morningstar OBSR investment strategist Andy Brunner has warned of the liquidity risks surrounding corporate bonds, which have seen an influx of investor cash, that may leave investors searching for an alternative.
‘From an asset allocation perspective, corporate bonds are perhaps one of the areas of most concern; market participants are hugely overweigh an asset where the potential for excess returns has declined significantly and where liquidity is a major issue,’ he said.
Brunner added that for the moment the ‘fundamentals just about stack up’ for corporate bonds but ‘an alternative will eventually be needed and it may even be cash’.
The value in EU debt has declined, said Brunner, but this has not put off investors whose thirst for yield ‘kept them coming back for more’.
Although he said there is benefits of holding to corporate debt compared to government debt ‘it must be remembered, however, that this is a bet that nearly all institutional and retail fund managers are taking and while fundamentals still appear sounds, investors must consider whether they are being adequately compensated for the risk they are taking, including substantial liquidity risk’.
The liquidity risk lies in the fact that there is no stock exchange for corporate bonds which are largely bought over-the-counter with trading limited between professional. Investment banks have already run down stock to low levels and ‘turnover in American high-yield bond markets is less than half what it was in 2007’, said Brunner.
‘Many managers, rightly very concerned about liquidity, are trying to manage portfolios to allow for this,’ said Brunner. ‘As yet few commentators have turned against corporate bonds and for many, where spreads have tightened to levels below previous year end forecasts, they have simply revised them lower. On a six month view, credit will likely continue to outperform, led by riskier corporates but, the tighter corporate bond spreads become, the risk relative to government bonds also increases.’