If interest rates were to quickly rise, high-yield bond exchange traded fund investors may find it costlier to sell-off their positions as notoriously low liquidity in the speculative-grade debt market could cause problems for the ETFs.
Fixed-income observers are worried that investors will rush en masse at the last second to sell bonds in response to rising interest rates, Reuters reports.
Wall Street banks would have been able to soften the blow and buy these bonds. However, due to new regulations and capital requirements imposed following the financial crisis, these same banks could be forced to cut inventories as well.
“I look around and ask ‘at the end of the day how easy would it be to sell what I own?’, and the answer is it is much more challenging,” Jason Brady, a fixed income portfolio manager at Thornburg Investment Management, said in the article.
Higher quality, investment-grade debt securities have historically remained a more liquid area in the fixed-income market. However, less liquid speculative-grade debt securities could become vulnerable ahead. Firms like Voya Investment Management, which uses third party managers to subadvise its funds, are giving high-yield bond managers up to three days notice before issuing large redemption orders to make sure they can execute the trades in a timely fashion.
“Liquidity is illusory for most bonds,”Margie Patel, senior portfolio manager at Wells Capital Management, said in the article. “The only time you need it is when you can’t get it.”