Popularity of bond funds raises concerns

INVESTORS have embraced bond mutual funds and exchange-traded funds (ETFs) as sound and solid places to keep their money. But that growing popularity rings alarm bells with some regulators, who worry that these same vehicles could become sources of instability in a future market crisis.

The Federal Reserve, in a February report on monetary conditions, suggests that individual investors may have gotten the misleading impression that mutual funds and ETFs trade more readily than the bond markets themselves, and the consequences could be quite serious. "These funds now hold a much higher fraction of the available stock of relatively less liquid assets - such as high-yield corporate debt, bank loans and international debt - than they did before the financial crisis," the Fed said in the report.

And as the funds expand, they may pose a threat, it said: "Their growth heightens the potential for a forced sale in the underlying markets if some event were to trigger large volumes of redemptions."