Fitch Ratings warns of the temptation that fixed income fund managers may have in current market conditions to overreach for yield, potentially loosening credit selectivity and leading to excessive credit and liquidity risk-taking.
Fund managers may be tempted to look for opportunities in lower-rated, less liquid, off-benchmark or longer-maturity bonds. This can lead to excessive risk-taking – there is a growing consensus among asset managers that the risks are beginning to outweigh the rewards, due to an overall increase in liquidity, re-pricing and idiosyncratic risk.
The inability to maintain discipline in credit selection and liquidity risk management, or the inability to de-risk the portfolio in a timely manner may put pressure on some fixed income Fund Quality Ratings. Furthermore, a potential change in market regime or market re-pricing (exacerbated by poor liquidity) may lead to more differentiation between funds’ performance, which in turn could lead to select rating actions.