Bond fund managers who cater to defined contribution pension plans and/or treasury cash investment managers are bracing for redemptions at quarter end. Valuations in the investment grade credit, sovereign, high yield and emerging markets have all come under pressure in recent weeks, forcing fund managers to consider further selling to generate liquidity to meet quarter-end redemptions. That means the bloodbath could worsen, raising the question: should corporate investors bail out before the next leg down?
The selloffs in EM and HY markets have been driven in large part by crossover investors diving back under their mothers’ skirts in the treasury markets, and it has been exacerbated by a lack of buying by the sell side, which has its hands tied by worries over capital and its inventories of EM and HY credits. This has forced fund managers across the board to position themselves defensively – shortening durations, moving up the credit profile and so on. They had only partly done so, as a group, when the Bernanke testimony on June 19 blew a hole in market confidence.
This is a quandary for corporate investors, especially since real yields in most fixed income markets are now less attractive than those available in the equity markets, which are off limits (as well as subject to their own lofty valuations). This means rotation out of EM and HY, into equities could turn into a flow out of EM, HY and equities into cash. Significant flows into commercial paper and short-term floating rate debt would be a boon for issuers, perhaps, though rates can’t go below zero. However, for investors, further yield compression at the ZIRP from fund flows will counter any hope that Bernanke’s talk of tapering could finally yield some yield on the short end.
So the question becomes one of estimating where (and if) the brakes will be applied. Round after round of forced credit selling was the proximal cause of the financial crisis; those who held their nerve were repaid with massive losses. If a similar dynamic is in the cards now, treasurers could be wise to grab their chips and run out the door.