UK hedge fund Man FRM has issued a warning about the more “esoteric” parts of the high yield market that it says could freeze up in a rising interest rate environment.
In a market note to investors, Man FRM noted that broader liquidity could become a "structural concern" as the credit cycle comes to an end.
"While some hedge fund managers have been generating ‘alpha’ from more esoteric parts of the debt landscape, the returns from others ones have been flattered by this rather suspicious looking free-lunch," said the note.
"The bulk assets seeking ‘yield at any price’ across various credit instruments is increasingly worrying to us," said Man Group.
Sentiment in less liquid markets can turn quickly, and when central banks drop their role as the "backstop buyer of debt", it is not clear who will play the role, said the note.
"After ten years of cheap money it isn’t obvious where the most dangerous leverage is hiding…but we believe there must surely be some companies out there that can survive only when capital is at the historically cheap levels we’ve seen over the last decade," said Man FRM.
"We believe market instability now is from higher US real rates and strong relative US growth, while the more telling risk to bigger picture stability comes from ‘end of cycle’ type economic weakness."
Man FRM was founded in 1991 and acquired by Man Group in 2012.