Massive redemptions in the bond market. Redemption risk—the risk that a large number of investors in a particular sector will decide to sell—is something investors should be aware of. Over the past few months, municipal bond funds have seen massive outflows over growing concerns that many state and local governments are overstretched and won't be able to fulfill their obligations. Since the start of 2007, muni bond funds have seen inflows of about $120 billion, according to TrimTabs Investment Research. "A lot of money has gone into municipal bond funds up until really November," says Vincent Deluard, executive vice president at TrimTabs. Since November, investors have pulled about $34 billion from these funds. The past three months have seen steady outflows.
Marilyn Cohen, co-author of the upcoming book Surviving the Bond Bear Market, says investors in bond funds should be aware of redemption risk. Investors in muni bond funds have seen how quickly a selloff can occur, and Cohen says it could happen in other types of bond funds, including corporates and emerging market bond funds. She sees a bond bear market ahead, in which interest rates rise regardless of the Fed's moves. In that environment, many investors would suffer losses they wouldn't typically expect in a bond fund. "It's coming because we haven't excepted fiscal prudence either as a country or as individual states, for the most part," Cohen says. In recent months, interest rates have slowly moved higher. Since the Fed's QE2 announcement in November, the yield on the 10-year treasury has risen a full percentage point, to 3.5 percent. Cohen warns that this is just the beginning.