Fed Lifeline Shields Bond Funds Teetering on Brink of ETF ‘Hell’

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The Federal Reserve’s unprecedented step into U.S. corporate bonds helped cure many of the massive dislocations in exchange-traded funds -- and may have saved mutual funds from a similar fate.

After prices for the biggest fixed-income funds held in a kind of dazed stillness during the worst of the sell-off -- presumably because the bonds they owned simply weren’t trading -- net-asset values on some of them dropped precipitously earlier in the week as their outflows forced sales on a frozen market.

The steep declines were beginning to mirror prices reached in fixed-income ETFs, which were already trading at deep discounts to their underlying securities. Faced with $149 billion of redemptions so far in March -- after not seeing a monthly outflow since January 2019 -- mutual funds were forced to sell their holdings into a market caught in a cash crunch.

However, the Fed’s pledge Monday to buy investment-grade credit and certain ETFs helped halt the slide in mutual fund net-asset values and sparked a rally in higher-rated debt. That’s largely due to the fact that fund managers now have a willing buyer on the other side of the trade, according to Bloomberg Intelligence.

“Mutual funds dodged a big bullet by not having to unload bonds into a market with no buyers,” said Eric Balchunas, senior ETF analyst. “The Fed has now brought liquidity, and so they will get to avoid the ‘hell’ we saw ETFs in for the past month.”

The pain had just started to spread to mutual funds, which were initially able to satisfy redemptions by burning through cash and their more liquid securities, according to Kingsview Wealth Management’s Paul Nolte. The net-asset values began to drop as the fund managers were forced to try and liquidate harder-to-unload holdings into a market with few buyers -- but the Fed announcement broke the cycle, he said.

“They’ve stepped in, and we’re now finally starting to see a little bit more of a normal bidding process in the market,” said Nolte, a portfolio manager at Kingsview Wealth Management. “We’re probably a week away from a normally functioning market. It’s going to take some of these funds a while to work their way back to where they used to be.”

https://bloomberg.com/news/articles/2020-03-28/fed-lifeline-shields-bond-funds-teetering-on-brink-of-etf-hell

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