Michael Aronsteins Warning to Fund Investors

Michael Aronstein

Fixed-income investors may think rising interest rates are their biggest worry. But bond funds face a new risk, driven by their need for liquidity to service investors’ daily redemptions, according to Michael Aronstein.

Since the financial crisis, fixed-income assets have swollen to $38 trillion and are now nearly three times the market capitalization of the equity markets, according to Aronstein. Under the Dodd-Frank law, banks have been under pressure to “de-risk,” he said, and the only fixed-income assets they hold are high-quality Treasury bonds.

As a result of banks’ de-risking, mutual-fund investors have upped their risk and now own lower-quality debt. Funds have accumulated emerging-market and lower-grade corporate bonds, according to Aronstein.

“The risk has been transferred to the mutual fund industry,” he said.

Bond funds must confront a liquidity mismatch. They advertise daily liquidity, but the underlying instruments that they own “do not have daily liquidity or anything like it, at least not at prices that are near the prices that they carry,” Aronstein said.

Aronstein is president and chief executive officer of Marketfield Asset Management LLC and portfolio manager of the Marketfield Fund (MFLDX). He spoke Sept. 19 at a dinner in Dallas, sponsored by Sincere & Co. and held in conjunction with Bob Veres’ Insider Forum.

Aronstein recalled similar crises – the failures of Bear Stearns’ collateralized debt obligation in 2007 and auction-rate preferreds in 2008 – that were painfully familiar to the advisors in the audience.

“Those weren't random acts like meteorites were falling on firms.” In all cases, the crisis was driven by illiquidity, Aronstein said.

Blame the Fed

Today’s situation was predictable in the aftermath of the financial crisis. Aronstein placed much of the blame on the Fed.

Beginning in 2008, investors understandably gravitated toward safer and less volatile assets as the world went through what Aronstein called a “depression.”

Now, he said, most investors’ portfolios are too biased toward what they think are safe assets. Investors prefer illiquid assets, like bonds. Aronstein said they are paying a premium for that safety relative to what other assets with similar or better risk-and-return characteristics would cost.