Surging market volatility is making regulators increasingly concerned that bond funds have loaded up on hard-to-sell assets.
The U.S. Securities and Exchange Commission has stepped up exams of money managers, while pushing mutual funds to test whether they could satisfy customer redemptions during periods of financial stress, said people with knowledge of the plans. Federal Reserve officials have reached out to the biggest investment firms to quiz them on markets after price swings for stocks, currencies and commodities hit a 13-month high last week, said a person briefed on the discussions.
“I certainly received a lot of calls from many regulators worldwide over the last few weeks asking me what’s going on,” BlackRock Inc. Chief Executive Officer Laurence D. Fink said in an Oct. 21 Bloomberg Television interview. The New York-based firm is the world’s biggest money manager with $4.5 trillion of assets.
A focus for regulators is ensuring that investors know the dangers of putting their cash in funds that trade daily yet invest in less-liquid assets such as loans and junk bonds. Last year, customers plowed a record $62.9 billion into leveraged- loan mutual funds, bringing their share of non-bank institutional lending to more than 30% from less than 20% in 2012, according to Lipper and Loan Syndications and Trade Association data.
SEC spokesman John Nester and New York Fed spokesman Jonathan Freed declined to comment.
Concern is mounting that as the U.S. central bank exits from almost six years of easy-money policies, debt that’s benefited most from the stimulus will lose value and investors as yields rise.
Mutual funds, exchange-traded funds and households are now the biggest holders of dollar-denominated corporate and foreign bonds, accounting for 30% of the debt from less than 20% in 2007, according to International Monetary Fund data.
Examiners from the SEC’s inspections group have made it a priority in recent months to ask money managers about their ability to sell certain bonds if trading dries up, said the people, who asked not to be named because the reviews are private. The SEC unit, which tries to spot market risks and ensure firms are complying with securities laws, is also checking disclosures that fund managers have made about how a jump in interest rates might affect their debt investments.
A big concern is that some firms are investing in infrequently-traded leveraged loans and high-yield corporate bonds, while adhering to a mutual-fund requirement that clients be able to pull their cash daily.
In times of stress, “it’s a game of hot potato,” Tony Crescenzi, a strategist and fund manager at Pacific Investment Management Co., said in an Oct. 21 Bloomberg Television interview. “When one wants to go to sell, it’s more difficult, so one has to be very careful about liquidity.”
Worries about funds being able to meet redemptions are overblown, said Brian Reid, chief economist at the Investment Company Institute, the mutual-fund industry’s biggest trade group. Mutual-fund and ETF investors provide a stable source of cash and don’t move it around that frequently, he said. This is especially true now, with a growing proportion of older Americans investing in bonds as they approach retirement.
The majority of the U.S. mutual-fund industry’s $15 trillion of assets is invested in frequently-traded government debt and stocks.