Recent chatter about adding exit fees to bond funds to try and curtail a rush to the exits when interest rates start rising should not be taken seriously, and it would never pass muster at the Securities and Exchange Commission.
But the mere notion of tacking on fees to funds that investors already own underscores how deeply muddled the Fed's monetary efforts have become.
While the Fed is finally on course to wind down its unprecedented bond-buying adventure, known as quantitative easing, it is now sitting on a $4.3 trillion bond portfolio and has been holding interest rates near the floor since the start of the financial crisis.
Now, after investors have poured more than $1 trillion into bond mutual funds in an effort to scratch out some semblance of yield, there is some
semi-serious debate over installing speed bumps in anticipation of those same investors trying to avoid the Fed's latest maneuver.
“I won't tell you exactly how many, but I've been in this business for a number of years and I've not seen anything along these lines where the Fed is suggesting imposing fees to the SEC,” said Jennifer Vail, head of fixed income research at U.S. Bank Wealth Management.
“That is something that could actually end up driving investors to individual securities, which could be problematic for individuals needing diversification,” she added. “Also, if you're considering whether to invest in a bond fund, the idea of an exit fee might effect that decision.”
Again, the exit-fee concept should be taken with a grain of salt because it is far removed from a realistic possibility. But the conversation sadly highlights the kind of uncertainty that lies ahead for bonds.
“The irony is that Dodd-Frank and the Volcker Rule have exacerbated the liquidity problems in the fixed income market that the Fed is now worried about,” Ms. Vail said. “It was already not a highly-liquid market but the Volcker Rule shrinks the size of the inventories for compliance, which in essence reduces liquidity.”
Todd Rosenbluth, director ETF and mutual fund research at S&P Capital IQ, agrees that exit fees would be problematic, but he doesn't expect investors to head toward the exits the way they did last year when interest rates spiked suddenly.
“At this point, most investors should be prepared for higher interest rates, with the Fed tapering under way and discussions of a higher funds rates coming in 2015,” he said. “Assuming investors act rationally, we shouldn't see the kinds of outflows we saw last year.”
Getting back to that shrinking corner in which the Fed appears to have painted itself, being a nimble bond fund investor is the only strategy at this point.
“Right now the Fed is the midst of the most radical experiment in history, and it is way out in uncharted territory,” said Michael Aronstein, manager of the $20 billion MainStay Marketfield Fund (MFLDX).
“There are consequences to radical policy and they often take a long time to manifest and people don't always see the cause and effect,” he added. “For all the intelligence there, the Fed has no prognostic insight and they haven't yet figured out the difference between walking a dog and walking a tiger.”
