Fund managers warn of growing bond bubble

A growing number of professional investors are warning that bonds are overvalued as fears grow that a fixed income bubble will collapse in a disorderly sell-off.

Four out of five fund managers said bonds were overvalued in a survey of 300 global managers by CFA UK. Corporate bonds are more overvalued than ever before, while government bonds are the most overvalued asset class, the group said.

The group, which represents 11,000 investment professionals, says their valuations index, running for three years, is flashing red over the high valuations of bonds.

Brad Crombie, head of fixed income at Aberdeen Asset Management, said: "You only know you're in a bubble when it pops. But this market could pop. There is more tension and anxiety over valuations than for a long while."

In the past six years, low interest rates and central bank quantitative easing have spurred a desperate search for yield. This has encouraged investors to buy investment grade, high yield and emerging market bonds to supplement treasuries and gilts.

But bond trading volumes have not expanded as fast as the funds’ bond holdings – new capital rules have made it more expensive for banks to keep large trading books and the new US Volcker rule has barred US banks from trading out their own accounts.

Investment managers fear bond markets could seize up if falling prices or a financial crisis prompt investors to pull their money out. Without the banks to act as backstops, there may not be enough institutions prepared to buy bonds when the funds have to sell.

The stakes have also risen for the fixed income markets because the US Federal Reserve is expected to increase interest rates this year for the first time since 2006. Investors say the move will spark volatility and could cause a mass rush to the exits, even though the monetary tightening has been well flagged.

However, some investors said worries over a bond bubble and big sell off are overdone because rising interest rates would confirm that the US economy is on the mend, which would be positive for corporates and their bonds.

– (Copyright The Financial Times Limited 2015)