“When markets turn, the exit door is far narrower than investors understand”; as investors seek to sell down some of their fixed-income holdings, the lack of a Wall Street escape outlet for the debt has suddenly become a problem

June 16, 2013 7:00 pm

Markets on edge as investors seek exit

By Tracy Alloway and Michael Mackenzie in New York

Mom and pop investors who flocked to the great bull run in bonds are now facing a messy exit thanks to striking changes in one of Wall Street’s biggest markets.

The rise of exchange traded funds has given retail investors instant access to a range of debt including high-yield, inflation-indexed and investment grade bonds.

At the same time, big banks which buy and sell bonds on behalf of the funds say they have cut their inventories of corporate debt due to new financial regulations.As retail investors start pulling money out of fixed- income ETFs and mutual funds, their fund managers have the difficult task of trying to sell large amounts of bonds in the secondary market, where the “dealer banks” have reduced their activities.

“When markets turn, the exit door is far narrower than investors understand,” said Richard Tang, who heads North America sales for RBS Securities.

With the Federal Reserve meeting this week, the bond market is on edge as the prospect of more investors clamouring for their money back from fixed-income ETFs and mutual funds threatens to exacerbate upward pressure on yields.

Dealer banks’ inventories have fallen from a peak of about $235bn in 2007 to as low as $37bn in July of last year, according to Fed data.

The banks’ stockpile of bonds now stands at $55bn and has been ticking up slightly in recent weeks.

“There’s a lot of indigestion on the Street,” said one dealer at a large bank. “I don’t think we’ve had a cathartic washout yet.”

The fall in inventories was a development that mattered little when there was a rush for debt, as seen by the $52bn of orders for Apple’s $17bn bond offering in April.

But as investors seek to sell down some of their fixed-income holdings, the lack of a Wall Street escape outlet for the debt has suddenly become a problem.

Banks and big institutional investors have been grappling over how to improve liquidity in the corporate bond market for months, even holding a series of private meetings to discuss the issue in the hopes of spurring an industry-wide solution.

“We have been talking about the liquidity challenge in the corporate bond market for some time,” said Richard Prager, who heads trading and liquidity strategies at BlackRock.

He noted that the recent jump in bond yields is a stark reminder that the debt market should be standardised in terms of bond issuance in order to function more orderly over the full investment cycle of a bull and bear market.

Dealers say that the recent rush into fixed- income assets may be part of problem.

Justin Gmelich, head of credit trading at investment bank Goldman Sachssaid: “Because the funds which own credit risk have become more concentrated, the required liquidity is out of balance with the dealer community’s capabilities.”