Index fund managers are finding it challenging to ensure the bonds they need in the prices they want, driving them to make trade-offs that leave supervisors vulnerable in a market downturn and may hurt investors.

Bond liquidity has all but dried up for corporate problems after new regulations and capital requirements compelled Wall Street banks to slash their stocks of fixed income products following the fiscal disaster. That’s especially challenging for index fund supervisors who must get certain bonds to be able to monitor specific standards.

The lack of liquidity additionally means funds could have trouble selling bonds in the event interest rates rise and also the investors who have sunk about $1.2-trillion (U.S.) in net deposits into long-term bond funds since the end of 2004 head for the exits. The Financial Stability Board (FSB) is analyzing whether exchange-traded funds pose a hazard to the global financial system for exactly that reason, in accordance with the Bank of Canada’s representative to the committee. Continue reading →