Anxiety over the inflated size of bond funds has until recently focused on how managers can wisely allocate such huge amounts of capital. But that discussion has now inverted: the new question is how bond funds will cope with massive outflows.
The issue was encapsulated in December when a £530 million open-ended bond fund in the US, Third Avenue Focused Credit, suspended redemptions as it struggled to pay back investors.
Third Avenue’s then chief executive, David Barse, said the combination of high outflows (£2.4 billion in 2014) and low bond market liquidity had made it ‘impracticable’ for the fund to meet redemptions ‘without resorting to sales at prices that would unfairly disadvantage the remaining shareholders’.
This serves as a warning for fund managers and investors alike. Should managers pay closer attention to the capacity of their funds, as becoming too large may force them to hold increasingly illiquid assets? And should investors redeem from large bond funds before others do, as waiting too long may leave them trapped like Third Avenue unit holders?
On the asset management side, several firms acted in 2014 to stem flows into popular bond strategies. TwentyFour soft closed its £1.5 billion Dynamic Bond fund and Kames its £1.8 billion Absolute Return Bond fund, for example.
Adrian Hull, a fixed income specialist at Kames Capital, explained that such decisions were neither purely strategic (based on a manager’s style) nor tactical (based on market conditions), but were instead ‘a bit of both’.
‘We’re not trying to say a fund is £2.2 billion and that’s that,’ said Hull. ‘We may say it could be £2 billion or £2.5 billion with some flexibility, but it’s not going to be £5 billion. It’s a practical approach based on market conditions and how the portfolio is constructed.’
The largest fund in Citywire’s Sterling Strategic Bond sector continues to be Richard Woolnough’s M&G Optimal Income at £16.6 billion, with a 42% market share despite net outflows worth an estimated £5.8 billion over the past six months, according to Citywire research.
In 2012, after heavy inflows, M&G did seek to slow purchases of its Corporate Bond and Strategic Corporate Bond funds, both also managed by Woolnough. But it has taken no such action with Optimal Income given its wider investment mandate.
Woolnough has remained confident in his ability to manage such a huge fund, noting that he faced questions about its size even when it held only a fraction of its current assets. He added that M&G also expanded its bond team to help manage the portfolio.
And as the fixed income environment turned from enthusiasm to fear in recent years, Woolnough has argued there is an illiquidity premium to be earned from tight bond markets. He recalled that liquid corporate credit conditions in 2007 did not presage stellar returns, while the illiquid spell following the crash turned out to be a strong buying opportunity.
On the buy side, Ian Brady, chief investment officer at Harpsden Wealth Management, arrived at an aversion to giant funds because he sought funds with concentrated portfolios. ‘We didn’t want a fund that was too disparate, and we were acutely aware of liquidity,’ he said.
Yet for investors requiring a more niche approach than is typical in the broader strategic bond sector, size can be an asset. For example Robert Lockie, investment manager at Bloomsbury Wealth, likes short duration mandates.
‘That universe is pretty small, and in that space you need to have a big fund because otherwise your costs are spread across fewer assets and therefore your total expense ratio is ridiculously high.’ His chosen fund’s ratio has fallen from 50 to 30 basis points as it has grown, for instance. So small is not always beautiful when it comes to bond funds.
First published JANUARY 13 2016 BY: ROBERT ST GEORGE, CITYWIRE
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