Barrons: ‘No Exit from Bond Funds?’

Barrons columnist Randall Forsyth is writing this week about an intriguing – and somewhat scary – proposal: That the Federal Reserve is considering placing exit fees on bond mutual funds to prevent a potential run when interest rates rise. Here is his core paragraph:

(I)t might be well that the Federal Reserve appears to be thinking about the consequences of the end — and eventual reversal — of its massive experiment in monetary stimulation. Last week, the Financial Times reported that the central bank is mulling exit fees on bond mutual funds to prevent a potential run when interest rates rise, which, given the ineluctable mathematics of bond investing, means prices fall. Quoting “people familiar with the matter,” the FT said that senior-level discussions had taken place, but no formal policy had been developed.

Forsyth says that Fed Chair Janet Yellen, when asked last week about the possible move, answered that the matter “is under the purview” of the Securities and Exchange Commission. In other words, she didn’t deny it.

That was the first I heard of the proposal. Here’s a link to the Financial Times article: ‘Fed looks at exit fees on bond funds‘ and the core paragraphs:

Officials are concerned that bond funds are becoming “shadow banks”, because investors can withdraw their money on demand, even though the assets held by the funds can be hard to sell in a crisis. The Fed discussions have taken place at a senior level but have not yet developed into formal policy, according to people familiar with the matter. …

Exit fees would seek to discourage retail investors from withdrawing funds, thereby making their claims less liquid and making a fire sale of the assets more unlikely.

The idea of exit fees wouldn’t be popular with investors, who likely would be trying to sell bond funds during an already sharp fall. The exit fee would increase their losses. I haven’t seen any indication how large a fee is being considered.

Interest rates are likely to rise over the next two years. And if bond yields rise, and prices fall, bond-fund holders will benefit from the higher yields, eventually regaining the lost asset value. A sharp decline in bond prices could actually create a buying opportunity, just as many people are selling out.

But an ‘exit fee’ proposal seems to indicate the Fed and SEC are worried about a market reaction to higher interest rates and the potential of a ‘crash’ in the bond market. And that worries me.

About these ads
This entry was posted in Investing in TIPS. Bookmark the permalink.

10 Responses to Barrons: ‘No Exit from Bond Funds?’

  1. Ed says:

    Are their any such exit fees existing in the world already? Where, and how big?

  2. tipswatch says:

    I know that Vanguard used to have a ‘redemption’ fees on some funds, only applied if a fund was sold within a certain time period, such as 90 or 180 days. This was designed to discourage frequent trading. The fee was pretty small, like 0.25%. More info:

    http://www.bogleheads.org/wiki/Redemption_fee

  3. Len says:

    On the other hand, those who purchase individual bonds like to pretend that when interest rates rise they aren’t sustaining any sort of loss. That is they don’t mark their bonds to market in a rising rate environment in the hopes they will hold them to maturity. If the bonds are inflation-indexed this may have some credibility since inflation is (supposedly) covered. Anyone ever tried transferring a bond from Treasury Direct to a brokerage account to sell same? Ugh! In any event some increase in rates may already be priced into bond prices now, in anticipation of rising rates.

    For myself, I would no more attempt to predict future interest rates than I would future stock market prices. I’ve known people who stayed short for years anticipating higher interest rates and only fooled themselves. The Fed! I remember when the story was communism would never work because of over-management, And what do we have now???

  4. tipswatch says:

    Len, I am one of those ‘dolts’ who buys TIPS, holds them to maturity, and never marks them to market. The only thing I track is current accrued principal, and I have never sold a TIPS before maturity and never will. (I have some EE Bonds paying 5% that I will probably sell before maturity, but that’s another topic.)

    I agree that it is impossible to predict interest rates but I do believe that today’s ultra-low rates are an outlier that can’t continue. Eventually we will return to the norm, and possibly much higher. Same with inflation. It has been very low, but eventually back to the norm, and possibly much higher.

    The stock market has had a very nice run for nearly six years. Back to the norm? And possibly much lower?

    • Len says:

      Well if (as you obviously do) understand the math then you aren’t a dolt. Nor are you deluded into thinking that your investment is stable when in fact it fluctuates with interest rates until final maturity.

      As for the rest…. we can’t predict, but we are below the norm (average?). Every year, more or less, the average changes with the addition of another year’s data to the data set. There may be some folks in Japan still waiting for a return to the norm and its been 25 years now. IF I knew I’d have bought that island by now….

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s