The International Monetary Fund warned on Tuesday of the large positions that mutual funds in the United States have built in high-yielding bonds issued by risky companies here and in emerging markets around the world.
The warning comes at a time of increased nervousness about China and other emerging markets like Brazil. And it highlights a growing concern on the part of regulators and economists that mutual funds, in their hunger to load up on high-risk, high-yield securities in a low interest rate environment, will be hard pressed to sell them during a market reversal.
Last week, the Securities and Exchange Commission, which regulates fund companies, proposed a series of rules and regulations intended to bolster the practices of mutual and exchange traded funds when it comes to returning cash to investors.
The reports were part of a broader research overview that the I.M.F. was presenting ahead of its fall meetings, which are to be held in Lima, Peru, starting next week.
In particular, the I.M.F. said that the bountiful amounts of cash that have moved around the marketplace in this era of extraordinary central bank activism had given many investors a false sense of security in terms of their ability to sell assets on demand.
“Even seemingly plentiful market liquidity can suddenly evaporate and lead to systemic financial disruptions,” the authors of the report concluded.
As it has in the past, the I.M.F. said in its report that the tendency of many American mutual funds to hold large concentrated positions in the securities of hard-to-trade emerging market companies posed a risk for financial markets.
Most large investment banks no longer actively trade these securities, increasing the danger that a contagious bout of selling could spread through the financial marketplace, the fund’s economists noted.
Although the language of the fund’s experts was muted, their words of caution highlight increased investor unease about the slowdown in China and other large emerging markets.
Skittish investors in the United States have to date pulled close to $100 billion from global bond and equity funds this year, according to the data profider EPFR, with institutions that focus on global bonds such as Franklin Templeton and Pimco suffering the most acute outflows.
Underpinning the I.M.F.’s worries has been the tremendous increase in bonds issued by a range of large emerging market corporations, including energy firms in Latin America and steel companies in Southeast Asia.
Two countries that have been at the center of investor concerns — China and Turkey — were highlighted in the fund’s study on emerging market debts. These two economies experienced the largest increases in corporate debt since 2007, with China company debt up 27 percent and Turkey up around 24 percent.
Since 2004, corporate debt in emerging markets has soared to $18 trillion in 2014 from $4 trillion in 2004. Bonds issued in dollars have been the fastest-growing subsection of this category, increasing to $855 billion last year from $163 billion in 2003, the I.M.F. calculates.
Mutual funds in the United States have been the most aggressive buyers of these securities, and the fear is that, as these economies slow and their currencies tumble, the companies will default and it will be the American mutual fund investor who will be left with the bill.
Although the I.M.F. and other international watchdogs such as the Bank for International Settlements, a clearinghouse for global central banks, have been highlighting this concern for some time, there has been little evidence to date of mutual funds being unable to sell their bonds when asked to do so by investors.
And mutual fund companies have vigorously defended their policies in terms of providing liquidity to investors. Many fund companies have taken extra precautions such as arranging for credit lines from banks and increasing levels of cash or securities that are easy to sell.
But analysts who keep a close eye on how easy — or hard – it is to sell bonds in the market these days say that these steps may not be enough, especially if, as is often the case in a market panic, investors head for the exits in unison.
“There have been a lot of people going into these types of illiquid investments,” said Stephen Tu, an expert on market liquidity at the credit rating firm Moody’s. “If we have a real liquidation event, solutions such as credit lines are going to be inadequate.”
(NYTIMES)
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