Redemptions jolt funds

Global fund managers are seeing a wave of redemptions as investors sell stocks, bonds even gold due to a "cash-is-king" sentiment on recession fears triggered by the coronavirus pandemic, but the massive economic stimulus and aggressive quantitative easing by governments might limit further downside risks.

Global bond funds suffered the second record week of redemption despite rally in global equities, with a US$109 billion (HK$850.2 billion) outflows for the week of March 19-25, according to Jefferies and EPFR Global. At the same time, investors pumped a record US$235 billion into global money market funds while US MMF absorbed a record-setting US$255 billion.

The recent massive sell-off has added more pressure on some asset management companies, especially hedge funds, which have already faced increasing investors redemption last year amid the economic slowdown.

In Hong Kong, Value Partners (0806) reported net redemptions of US$1.66 billion in 2019, dragged down by about US$2 billion redemptions from a white label client during the second half.

During the coronavirus pandemic, more fund houses, including big names such as BlackRock and Vanguard, raised redemption fees for some products, hedge fund manager Solus Alternative Asset Management even shutted down its flagship fund recently amid the liquidity mismatch.

The risk-parity funds, using a strategy popularized by Ray Dalio's Bridgewater, suffered biggest losses since financial crisis in 2008 in Mid-March. These funds, with an estimated asset under management of US$175 billion, were forced to sell across all asset classes to meet margin requirements when bonds and equities slumped together, exacerbating market crash.

The Securities and Futures Commission issued guidance to fund industry last Friday to remind insiders of their obligations to properly manage the liquidity of funds and ensure fair treatment of investors amid the increasing volatility in global markets.

Global stock markets rallied last week after ramped-up policy response from governments and central banks. The United States unveiled unlimited QE and a historic US$2 trillion fiscal stimulus. The Cboe Volatility Index, known as the "fear gauge", dropped 1 point to 60, its lowest level in 11 days on Wednesday, before rising back to 66 on Friday.

Investors started bottom-fishing global equities exchange traded funds even before the unlimited QE. Global equity ETF recorded its four consecutive week of inflows with US$372 million over the week ended March 25, data from Jefferies and EPFR showed.

Especially in China, Chinese mutual funds/ETFs saw a US$1.5 billion purchase during the week as investors added positions in markets where the Covid-19 outbreak has been under controlled. CSOP China A50 ETF (2822), tracking A shares, saw HK$555 million inflow last Wednesday, the largest single-day inflow since December 18, 2019, accounting for more than half of the total inflows year to date.

Gordon Ip, Value Partners' chief investment officer for fixed income, said the sentiment in the Asian markets has been improving since March 16. He said the China high yield bonds offers "extremely attractive" yield premium over both the US high yield and emerging market credits.

The US Federal Reserve also pledged last Monday to purchase corporate bonds in the primary and secondary market, which will help cushion any further widening among corporate credit spreads, according to Morningstar. Credit spreads in the corporate bond markets narrowed last week after widening to the second-widest level in 20 years, surpassed only by the 2008 financial crisis.

The selling pressure of funds invested in high yield corporate bonds and investment-grade bonds also abated, with the liquidation of US$6.2 billion and US$5 billion for the week of March 19-25, according to Jefferies and EPFR. A week before, the two types of bonds witnessed their heaviest withdrawals, with US$13.1 billion and US$17.6 billion outflows respectively.

Billions worth of investment grade bonds are under downgrade risks due to the impact of the coronavirus. Fidelity International expects US$100 billion to US$200 billion of investment grade bonds in high yield space will be downgraded. S&P Global Ratings and Moody's Investors Service are slashing credit ratings of US companies at the fastest pace in more than 10 years, the number of companies being downgraded tripled those being upgraded so far this year, according to Bloomberg. S&P has cut rating of Boeing to "BBB" from "A-".

The BBB bonds, the lowest-rated of investment-grade bonds, is one of the weakest links of the US market, according to Hong Hao, BoCom International's chief strategist. The low-interest-rate environment in the past few years has induced a large number of US companies to fund their share buybacks at low rates. The BBB bonds are accounting for nearly half of outstanding US corporate debts.

"Once the company's business deteriorates and its bond rating is downgraded, fund managers will have no choice but to dump their positions in accordance with the fund's terms," Hong said.

S&P expects the default rate of high-yield corporate bonds to rise to 10 percent by year end from 3.1 percent in December 2019, as a global recession is anticipated.

In Asia, Chinese property developers and banks are expected to bear the brunt, S&P said. Especially for developers, under huge pressure even before the pandemic due to China's housing market controls, are struggling with declining sales, delayed construction, and increasing default risk of massive offshore debt.

But Morningstar said a significant amount of the downside risk for corporate bonds has been priced in, given the current credit spreads are at levels similar to where they peaked during other times of market turmoil.

Andrew Wong Wai-hong, chairman and chief executive of Anli Securities, said some small hedge funds and asset managers may bankrupt due to the virus outbreak, but the number might be smaller than market expectation, thanks to central banks' liquidity support.