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IMF says high-yield bonds raise red flags

A board displaying stock indexes in Hong Kong on Tuesday reflected the ongoing woes facing China’s economy. PHILIPPE LOPEZ/AFP/Getty Images

NEW YORK — The International Monetary Fund warned on Tuesday of the large positions that mutual funds in the United States have built in high-yielding bonds issued by risky companies here and in emerging markets around the world.

The warning comes at a time of increased nervousness about China and other emerging markets such as Brazil. And it highlights a growing concern on the part of regulators and economists that mutual funds, in their hunger to load up on high-risk, high-yield securities in a low-interest-rate environment, will be hard pressed to sell them during a market reversal.

Last week, the US Securities and Exchange Commission, which regulates fund companies, proposed regulations intended to bolster the practices of mutual and exchange-traded funds when it comes to returning cash to investors.


The reports were part of a broader research overview that the IMF was presenting ahead of its fall meetings in Lima starting next week.

In particular, the IMF said the bountiful amounts of cash that have moved around the marketplace in this era of extraordinary central bank activism had given many investors a false sense of security in terms of their ability to sell assets on demand.

“Even seemingly plentiful market liquidity can suddenly evaporate and lead to systemic financial disruptions,” the report concluded.

As it has in the past, the IMF said that the tendency of many US mutual funds to hold large concentrated positions in the securities of hard-to-trade emerging market companies posed a risk for financial markets.

Most large investment banks no longer actively trade these securities, increasing the danger that a contagious bout of selling could spread through the financial marketplace, the Washington-based organization’s economists noted.

Although the language of the IMF’s experts was muted, their words of caution highlight increased investor unease about the slowdown in large emerging markets.


Skittish US investors have pulled nearly $100 billion from global bond and equity funds this year, according to the data provider EPFR, with institutions that focus on global bonds such as Franklin Templeton and Pimco suffering the most acute outflows.

Underpinning the IMF’s worries has been the tremendous increase in bonds issued by a range of large, emerging-market corporations, including energy companies in Latin America and steel companies in Southeast Asia.

China and Turkey were highlighted in the fund’s study on emerging market debts. Their economies experienced the largest increases in corporate debt since 2007, with China’s company debt up 27 percent and Turkey’s up around 24 percent.

Corporate debt in emerging markets soared from $4 trillion in 2004 to $18 trillion last year. Bonds issued in dollars have been the fastest-growing subsection of this category, increasing to $855 billion last year from $163 billion in 2003, the IMF calculated.

Mutual funds in the United States have been the most aggressive buyers of these securities, and the fear is that, as these economies slow and their currencies tumble, the companies will default and it will be the US mutual fund investor who will be left with the bill.

Although the IMF and others have been highlighting this concern for some time, there has been little evidence of mutual funds being unable to sell their bonds when asked to do so by investors.

And mutual fund companies have vigorously defended their policies in terms of providing liquidity to investors. Many have taken extra precautions such as arranging for credit lines from banks and increasing levels of cash or securities that are easy to sell.


But analysts say these steps may not be enough, especially if investors head for the exits in unison.

“There have been a lot of people going into these types of illiquid investments,” said Stephen Tu, an expert on market liquidity at Moody’s Investors Service. “If we have a real liquidation event, solutions such as credit lines are going to be inadequate.”