With an increasing number of large groups setting up credit lines to ensure that they are able to meet investor redemptions should the bond market slide., you'd imagine that this should, in theory at least, prevent funds being forced to close.
According to Jerry Wharton, portfolio manager of the Church House Investment Grade Fixed Interest Fund, it is not yet entirely clear how these credit lines will work: "They cannot be set up within individual funds, so groups are likely to take the bond assets onto their balance sheets, while paying cash into the fund to meet redemptions should the worst happen. It is a clear statement that many recognise that simply holding high cash weightings may not be enough to protect the very largest funds at times of poor sentiment towards bonds – which is a very real risk.
It is difficult to know the extent of the problem until it happens. In larger funds, it can be difficult to gauge whether investors are long-term shareholders or whether they may be swayed by sentiment, selling out at the first sign of trouble. The ideal position is to have committed investors, willing to hold on through market volatility.
Our fund has a largely private client investor base, either our own clients or those of other wealth management groups, which – we hope – will prove robust in the face of volatility. Many have invested with us for many years, and we believe we know them well and keep them in touch with what is going on in the fund. Nevertheless, as we have said before, we are acutely aware of the liquidity issues in bond markets and even though our fund is not of the same scale as those from the largest fund houses, we hold a liquidity pot. There is a level of complacency in certain parts of the bond market to which we do not plan to fall victim.
Within our liquidity pot, we have cash and short-dated gilts. We do not subscribe to the view that there is excessive credit risk in gilts. In the run-up to the Greek crisis, gilts have proved a safe haven, and so they should. We picked up more when the 10-year gilt rose to 220bps. At the moment, we have around 15% in short-dated gilts. The fund also has a maximum allowable weighting in cash, of 5% but we tend to hold this in gilts or T-Bills.
So, the real risk as we see it at present is a change in sentiment towards corporate bonds. This may be prompted by the Federal Reserve raising rates, or higher inflation, or simply a recognition that the yields are more attractive elsewhere. We consider this to be a particular risk for larger funds at present and as such, we have chosen to cap the size of our fund when it reaches £500m (currently £180m).