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No silver bullet answer to bond liquidity problem

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There is no silver bullet answer to the bond liquidity problem, says Gill Hutchison, Head of Investment Research at City Financial…

People have been worried about mass redemptions from bond funds for a long time, in part because they probably expected a normal cyclical economic recovery, accompanied by an increase in interest rates. This has clearly not transpired and with economic data indifferent and equity markets in a nervous, bearish mode, it is difficult to see why investors would wish to abandon bonds in their droves. 

Even after the horrors of 2008, only a small proportion of global mutual funds were actually liquidated. Countering this is the argument that retail participation through bond funds and multi-asset funds is greater than it was then, thanks to our low interest rate world. How some of these investors would respond to a sustained period of negative total returns is an open question.     
 
There is no silver bullet answer to the bond liquidity problem. We all know that daily-dealing, open-ended funds are an imperfect vehicle for any asset class that experiences liquidity problems but for the majority of the time, they are a satisfactory way for retail investors to invest in an otherwise inaccessible market. 
 
Markets are in a troubling, bifurcated state, distorted as they have been by extraordinary monetary policies. When contemplating the next phase, it is valid to consider the potential for a Japan-esque future, in which equities fail to make sustained progress for years and credit is the most rewarding asset class. In other words, don’t bank on a grand and seamless rotation from bonds to equities – your portfolios might still have a friend in corporate bonds.

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