Coronavirus crisis: hedge funds ramp up exit fees

Hedge funds have quietly raised charges for investors who want to cash out their holdings, in some cases by up to 2000pc.

Fund managers are raising sell spreads and more could follow suit. Picture: AFP

Corporate debt and sovereign bond hedge funds have quietly ratcheted up the costs charged to investors who want to cash out their holdings, in some cases by as much as 1500 to 2000 per cent, in a move that has added to a freezing of credit markets and threatens to derail attempts by super funds and insurers to rebalance investment portfolios.

The cranking up of “sell spreads”, which are a set percentage fee charged by portfolio managers because hedge funds must sell down some assets to provide cash to investors who want to make a withdrawal, is so severe that in a number of instances investors pulling out cash will have their expected returns vaporised by the exit fee.

The move now threatens the ability of large money managers, including superannuation funds and insurance companies, from rebalancing their investment portfolios following a dramatic sell-off in equities markets, as withdrawing funds invested in corporate and sovereign debt vehicles to buy shares will now be extremely costly.

In some cases, life insurers and other regulated investors will be unable to avoid rebalancing their portfolios in the event of a large-scale downgrading of corporate debt ratings, as regulators require companies to hold more capital against riskier investments.

According to Morningstar director Tim Wong, at least 16 fund managers have raised sell spreads over the last week and more could follow suit.

“Unfortunately, fund managers that have raised their sell spreads by large margins have made it much more difficult for their investors to manage their portfolios,” he said

AMP Capital and Vanguard have both increased the spread on their respective Australasian bond fund and Australian inflation-linked bond index fund from 0.1 per cent to 0.9 per cent— a nine-fold increase.

For portfolios carrying both global and Australian bonds, the spread increase has been sharper, with Macquarie’s dynamic bond hiking the fee from 0.08 per cent to 1.24 per cent — an increase of 1550 per cent.

The UBS diversified fixed income fund exit fee has been hiked from 0.1 to 0.7 per cent — a seven-fold increase.

Further, the most dramatic increases have been slapped on investors in credit and flexible bond strategies, where Kapstream’s absolute return income plus fund will charge withdrawers a 2 per cent spread, up from 0.1 per cent — a 20-fold increase.

Franklin’s Australian absolute return bond fund will now charge investors 1.75 per cent, whereas before it had a 0 per cent fee.

Mr Wong said some funds, such as Vanguard, have blamed higher currency hedging costs, while others, such as Schroders, have complained that “liquidity on Australian government and semi-government bonds has dried up significantly” to the point where the gap between the price buyers are willing to pay and the price where sellers are happy to sell has blown out 20 times wider than how they would normally trade.

“Several fund managers have reported that trading of credit has evaporated — extending even into high-grade sovereign bonds,” Mr Wong said.

The Reserve Bank has launched a massive unconventional monetary policy program where it is buying between $5 billion and $10bn worth of Australian government bonds every day in a bid to bring yields down, and to encourage investors into different assets that is hoped to calm down other fixed income and credit markets.

Fund managers are obliged to treat all investors equally and so the higher sell spreads are an attempt to balance the interests of those wanting to leave the fund against the interest of remaining investors who would bear the higher transaction costs from liquidating bonds.

Last week, $US36bn was pulled from hedge funds that hold safer investment-grade bonds including sovereign bonds — a record — meaning interest rates on government debt began to creep up, causing policymakers to worry.

Mr Wong said heightened sell spreads would only become an issue if an investor actually redeems their funds, which may be inadvisable in the current environment where most fixed interest portfolios have experienced large falls in values amid concerns about a potential wave of corporate defaults triggered by the oil price crash, and as governments shut down economies to limit the spread of COVID-19.

“Still, the mantra of staying the course ignores other reasons for wanting to exit an investment beyond panic,” Mr Wong said

“One obvious example is if an investor wanted to rebalance their portfolio, potentially reallocating out of fixed interest into another asset class. Automatic asset allocation rebalancing could be particularly problematic, as significant falls in equity allocations during the first quarter of 2020 are likely to be reweighted back by selling fixed interest exposures,” he said.

“Or perhaps investors just need liquidity to manage their personal circumstances, a requirement that may grow more acute if current circumstances persist. The imposition of very high sell spreads makes this very costly, to the extent that it raises questions over whether investors should rebalance their asset allocation at all.”

Mr Wong said concerted action by global central banks to lower interest rates and inject liquidity into the financial system could ease conditions in the market materially.

“It’s entirely possible that these higher sell spreads prove transitory,” he said.

“Having said that, this period has thrown a curve ball on conventional wisdom about the liquidity of even the highest grade bonds and portfolios that invest in them.”