Kames Capital – Central Banks have no duty to protect corporate bondholders

Central Banks should not provide further Quantitative Easing to alleviate the corporate bond liquidity issue according to Kames Capital’s fixed income product specialist Adrian Hull.
Hull says: “Central banks have various responsibilities, but a duty to protect corporate bond holders should not be on the list. One of the clear problems of QE is establishing its practical limitations – in other words where it should end – in terms of both timing and what is bought. But the current suggestions that QE should be extended to support bond funds runs the risk of further moral hazard.”
He explains that this moral hazard in respect to bond funds, is that managers can potentially run funds with expectations that liquidity ends up being someone else’s problem.
However, Kames believes that in its broadest sense, fund managers have a responsibility to manage their portfolios to the mandate that they have, which should also mean actively managing it to market conditions. This includes overall size, liquidity, and quality of assets as well as cash holdings. Any support from a third party suggests that the fund managers are shirking their responsibilities when it comes to these decisions.
Hull continues: “There is no doubt that liquidity is poor. Andrew Tyrie MP has raised this issue most recently with Bank of England Governor Mark Carney – although both the BoE and FCA have already raised concerns that it is an industry wide issue. But at the end of the day, fund managers have a responsibility to manage their funds to the prevailing market conditions – including liquidity. The industry has a responsibility to fund holders, so issues such as sizing and capacity need to be better self-policed otherwise the regulator will end up doing it.
“The Regulator does have a potential role in supporting this issue such as minimum cash holdings or indeed encouraging greater secondary market liquidity.  But there remain concerns that liquidity would dry up in what some are referring to as a ‘Northern rock type scenario’.”  Hull suggests such comparisons are unhelpful in the context of what the bond market is pricing.
He says: “One of the biggest threats to the bond market is around sentiment and media reportage as rates rise. Understanding what the likely outlook for rates is key to this debate. So what are they?
“Most economists see only a gradual change in rates and one of the problems of solely focusing on short rates as it misses the dynamic nature of pricing of longer maturities and credit markets where many corporate bond funds invest. A step change in both long and short term rates requires a step change in economic growth and inflation neither of which is predicted by the IMF or most city economists. In this environment it is not unreasonable to see positive returns from corporate bond funds albeit the returns of the early 2010s are unlikely to be repeated from where we stand today.”
In the event of a liquidity crisis there is obvious concern that vulnerable consumers will be exposed to a bond market sell-off, as post the economic crisis low interest rates have encouraged a wider consumer audience to consider corporate bonds in their search for income who would not previously have invested in them.
But in order to prevent this scenario fund managers have a duty of care to take in to account all considerations from liquidity, fund sizing and quality of assets when managing their funds, it should not be down the BoE or any other central bank to intervene with corporate bond QE.