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Prisoner’s Dilemma reveals bond fund risks 

March 8, 2016

Jonathan Guthrie, The Financial Times

The road to Hell is paved with well-intentioned risk management initiatives. Burgeoning bond funds are seen as amplifying risks of a market rout. Fund managers such as BlackRock in the US and Aberdeen Asset Management in the UK have set up extra credit lines as shock absorbers. But British regulators are now worried these could exacerbate a crisis rather than avert it.

The context is that higher capital adequacy thresholds mean banks are less able to smooth out market peaks and troughs. Last week, for example, the UK Treasury warned that a gilt auction might fail this year. Brexit jitters were one reason cited. Another was the supposed reluctance of a panel of primary dealers including BNP Paribas, Citi and Morgan Stanley to tie up capital by warehousing government securities during rough trading conditions.

The Debt Management Office, an arm of the Treasury, barely covered a £4bn sale of five-year gilts during a volatile spell in January.

The declining role of banks transfers some of the gyrations in demand to bond funds, many of which guarantee to redeem investments in a day.

Establishing new credit lines seemed like a sensible move to fund managers who were fearful that bond markets might seize up. Aberdeen established a $500m facility last year. Late in 2014, BlackRock lifted its own borrowing power from $500m to $2.1bn, according to filings. Eaton Vance, Goldman Sachs and Guggenheim Partners made similar moves. Read more

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