As fears of a global coronavirus-driven recession fuel a sell off in corporate debt, fund managers are bracing for a wave of redemptions, leaving the fate of credit funds that have ballooned in size and number in recent years hanging in the balance.
Should this pool of willing buyers dry up, companies are likely to struggle to raise funds at affordable rates just as they attempt to get back on their feet following worldwide business shutdowns to stem the spread of the virus, which originated in China in December.
This month's massive influx of monetary and fiscal stimulus from central banks, totaling trillions of dollars, in an effort to forestall an economic crash has had only a limited effect and the system is starting to creak.
Borrowing costs for non-investment grade, or junk, rated companies have already surged, and the broader market for new debt issuance is firmly closed as investors struggle to get a handle on companies' ability to repay their debts.
That uncertainty, combined with a broader rush for cash, led to a record withdrawals of $109 billion from bond funds last week according to data from Bank of America.
A stampede for the exit of such magnitude means that some "open-ended" credit funds — which largely let investors enter and leave any time they like — will need to suspend withdrawals if they fail to sell assets fast enough to meet redemption requests or are unable to accurately price their portfolio.
"Credit liquidity right now is a major concern," said David Beddington, chief operating officer at London-based systematic money manager Bayforest. "It's a huge area of pressure."
"Retail credit funds are going to have redemptions off the back of this and it's going to be a very hard market to trade. The prices are going down, sure, but there's very little volume behind those markets because people aren't really willing to trade, so forced redemptions right now are pretty ugly."
Nordic asset managers Danske Invest, Carnegie Fonde, Cicero Fonder and Jyske Invest have already stopped investors taking their money out of credit funds, even if only temporarily, as volatility made pricing impossible, as did a number of even more illiquid UK property funds managing around $14 billion.
While none cited redemption pressure, the concern is that the temporary 'gating' could ultimately spur longer-lasting suspensions, with a knock-on effect to other currently unaffected funds.
Meanwhile, US fund manager AlphaCentric is looking for buyers for more than $1 billion of US mortgage bonds to help cover outflows, the Financial Times reported.
Data from industry tracker Morningstar showed the world's 10-biggest credit funds - all US-based - were down between 2 percent and 7.7 percent in the month to March 17.
Among the worst performing were funds that were hedged or in currencies other than the US dollar.
Kevin Doran, Chief Investment Officer at retail investment house AJ Bell, said the prospect of fund suspensions was increasingly likely if lots of investors sought to redeem their investments.
"If funds were to see large redemption requests... the difference between where bonds are actually trading and where they're reported to be priced may see the funds with outflows also shutting the gates."
Suspending fund withdrawals ensures investors are treated fairly while providing portfolio managers with breathing space to shore up losses, but it can also increase redemption pressure on other funds if investors seek to raise cash.
Cheap central bank money has pushed fund managers to take ever riskier credit bets to generate returns since the global financial crisis in a world awash with negative interest rates.
The rush for yield allowed companies to save money by issuing bonds without paying for a credit rating on the paper, or to sell debt with weaker protection for investors, but such debt is a less attractive proposition in sliding markets.
"Most bond fund managers who invest in unrated securities do their own credit analysis and come to a conclusion, and will buy an unrated bond they think is equivalent to a triple-B rated or double-B rated security," said Jake Moeller, Head of UK & Ireland Research at fund tracker Lipper, part of Refinitiv.
"However, when a sell-off occurs, the market doesn't care, it's still unrated,"
Lipper data to the end of December 2019 showed the average global high-yield bond fund based in pounds, euros or dollars held nearly 10 percent of their portfolio in unrated debt, although some had much more.
The concern is greater still because, since the financial crisis, the global bond mutual fund market has seen huge growth in assets under management and was now "an order of magnitude greater in size", said Alastair Sewell, head of fund & asset manager group for EMEA and APAC at Fitch Ratings.
The scale of the inflows into bond markets could even trigger problems for funds holding better-quality credit if too many investors opt to liquidate easier-to-sell assets, said Lipper's Moeller.
The recent selloff in German government bonds, or Bunds, as stocks fell - they normally move in opposite directions - was a sign some asset managers were raising cash in preparation for an increase in demands to redeem, said Christoph Rieger, head of rates and credit research at Commerzbank.
"Clearly what is happening is that a lot of market participants have moved to cash preservation mode."