While not getting much mainstream press, the Fed may be thinking about what will occur as interest rates increase and its effect on the value of bond mutual fund prices. From a Barron’s article, June 21 Up and Down Wall Street::
“The Federal Reserve is floating a trial balloon, or at a minimum give bond investors a “heads up”. It might be well that the Federal Reserve appears to be thinking about the consequences of the end -- and eventual reversal -- of its massive experiment in monetary stimulation. Last week, the Financial Times reported that the central bank is mulling exit fees on bond mutual funds to prevent a potential run when interest rates rise, which, given the ineluctable mathematics of bond investing, means prices fall. Quoting "people familiar with the matter," the FT said that senior-level discussions had taken place, but no formal policy had been developed.
Those senior folks apparently did not include Fed Chair Janet Yellen. Asked about it at her news conference on Wednesday, she professed to be unaware of any discussion of bond-fund exit fees, adding that it was her understanding that the matter "is under the purview" of the Securities and Exchange Commission.
That nondenial denial leaves open the possibility that some entity in the U.S. financial regulatory apparatus is indeed mulling bond-fund exit fees. The Financial Stability Oversight Council established by the Dodd-Frank legislation oversees so-called systemically important financial institutions, or SIFIs, which include nonbank entities. And, indeed, the FSOC has considered designating asset managers as SIFIs, as Barron's has noted previously.”
Remember that in the jaws of the last financial crisis, a run on money market accounts during the fall of 2008 caused the Feds to alter money market fund status by temporarily guaranteeing them, equaling the protection of FDIC-insured bank savings accounts. This temporary guarantee expired in Sept 2009.
An exit fee for bond fund sales might be an attempt to stem potential fund outflows as rates increase. While most commentators do not believe this will actually happen, it is important for investors to take notice of the Fed’s worry.
Most of us have some bond funds and it essential for investors to understand the “interest rate risk” and its potential impact on that specific fund. While seemingly a complex calculation, it is actually quite easy. Most of the complicated math has been done for you and is reflected in two important bond fund fundamentals. These are “Average Maturity” and “Average Duration”.
The important takeaway is the topic of interest rate hikes is starting to gain traction, even within the inner circle of the Fed. How are you preparing for the next move up in the interest rate cycle and how will it affect your finances?
First published June 2014 issue of Guiding Mast Investments newsletter. I appreciate your time and interest in Guiding Mast Investments, George Fisher, Founder and Publisher