The Return of "Roach Motel" Funds

No, the real anomalies can be found in bond markets, and they're glaring. U.S. government bond yields hit fresh all-time lows this morning, with the benchmark 10-year bond now yielding less than 1.40%. But the U.S. yield curve still lies above the x-axis, at least.

Much like their clocks, Switzerland's bond market is officially cuckoo, with the yield on 50-year maturities falling below zero today. The entire stock of Swiss government bonds is now trading at negative yields.

Yields on the 10-year U.K. gilt, as the government bonds are known, also hit a historical low on Tuesday, dipping below 0.8%. A historical low means something in this corner of global finance: The U.K. raised its first gilt under King William III through the newly created Bank of England. The year was 1694, and the 1.2 million pounds issued was to finance the war with France.

Whether or not you agree with the ultra-accommodative monetary policy the major central banks have practiced in the wake of the financial crisis, the fact is, microscopic yields (to say nothing of the negative variety) do have consequences that are not always the ones policymakers might wish for.

The return of "Roach Motel" funds

Case in point: Aviva Investments announced today that it has shut the gate on investors who want to redeem their shares in its 1.8 billion-pound U.K. Property Trust mutual fund. This follows less than 24 hours after the announcement from another Standard Life that it had "gated" its 2.9 billion-pound commercial property fund -- one of the largest property funds in the country.

Of course, you can't put this entirely in the lap of central bankers -- indeed, it's the British people who provided the catalyst for these events. In the wake of the referendum vote in favor of Brexit, withdrawal requests from these funds have surged, as investors are concerned that commercial property values are not well supported in an economy that now looks vulnerable to the uncertainty the surprise result has created.

Furthermore, the wisdom of offering investors the opportunity to cash out on a daily of a fund that manages illiquid, long-dated assets is highly questionable. Nevertheless, faced with starvation yields on bonds, investors were willing to ignore that concern. The returns on U.K. commercial property from capital appreciation and rental income were simply too alluring. In the three years to the end of June, the FTSE ALL U.K. Property Index, which tracks retail, office, and industrial properties, rose 13.6% on an annualized basis.

This creates an unhealthy feedback loop: Strong inflows encourage fund managers to be less careful regarding the prices they are willing to pay if they want to keep the fund fully invested. That pushes property prices up, which is reflected in rising fund values, which attracts more investors.

The news regarding these two U.K. property funds is unnerving for those who remember the events of August 2007, when French bank BNP Paribas halted withdrawals from three of its funds that were exposed to the U.S. subprime market -- a canary in the coal mine for the crisis that would unfold. Are we in the same situation today? Certainly not, but it is an example of the pockets of excess that eight years of ultra-loose monetary policy have produced.

Unfortunately, it seems that, for central bankers, nothing succeeds like excess. UBS predicted last month that the Bank of England would implement two rate cuts by year-end, taking rates to zero.

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