Bond Liquidity Risk Defused by Cash

Rising interest rates unlikely to cause mass exodus of $3.5 trillion in U.S. fixed-income funds.

The record $3.5 trillion stockpiled in U.S. fixed-income funds is raising the specter the bond market will buckle under the strain of redemptions once interest rates rise. Simple math suggests there’s little need to worry.

While fund assets have almost doubled since the financial crisis, their size as a portion of all U.S. mutual funds is still in line with the 21 percent average over the past three decades, according to Investment Company Institute (ICI). Debt fund managers also hold almost 9 percent of assets in cash—close to the highest in a quarter-century and more than the maximum rate of outflows in 1994, one of the worst years for bonds.

At the same time, fixed-income funds have increased their cash cushions to 8.7 percent of assets from 7.3 percent a year ago. That’s more than the historical average of 5.4 percent. On a quarterly basis, the funds have had more liquid assets only once in the past 30 years—in the second quarter of 2011.

During 1994, when U.S. debt securities lost 2.75 percent in the worst year on record, outflows never exceeded 6 percent of bond fund assets in any quarter, according to JPMorgan.

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