Big fixed income shop prepares for the worst

TCW Group Inc. is taking the possibility of a bond-market selloff seriously. So seriously that the Los Angeles-based money manager, which oversees almost $140 billion of U.S. debt, has been accumulating more and more cash in its credit funds, with the proportion rising to the highest since the 2008 crisis. “We never realize what the tipping point is until after it happens,” said Jerry Cudzil, TCW Group's head of U.S. credit trading. “We're as defensive as we've been since pre-crisis.” TCW isn't alone: Bond funds are holding about 8 percent of their assets as cash-like securities, the highest proportion since at least 1999, according to FTN Financial, citing Investment Company Institute data. Mr. Cudzil's reasoning is that the Federal Reserve is moving toward its first interest-rate increase since 2006, and the end of record monetary stimulus will rattle the herds of investors who poured cash into risky debt to try and get some yield. The shift in policy comes amid a global backdrop that's not exactly rosy. The Chinese economy is slowing, the outlook for developing nations has grown cloudy, and the tone of Greece's bailout talks changes daily. DISTORTED MARKETS Of course, U.S. central bankers are aiming to gently wean markets and companies off zero interest-rate policies. In their ideal scenario, borrowing costs would rise slowly and steadily, debt investors would calmly absorb losses and corporate America would easily adjust to debt that's a little less cheap amid an improving economy. That outcome seems less and less likely to Mr. Cudzil, as volatility in the bond market climbs. “If you distort markets for long periods of time and then you remove those distortions, you're subject to unanticipated volatility,” said Mr. Cudzil, who traded high-yield bonds at Morgan Stanley and Deutsche Bank AG before joining TCW in 2012. He declined to specify the exact amount of cash he's holding in the funds he runs. Price swings will also likely be magnified by investors' inability to quickly trade bonds, he said. New regulations have made it less profitable for banks to grease the wheels of markets that are traded over the counter and, as a result, they're devoting fewer traders and money to the operations. To boot, record-low yields have prompted investors to pile into the same types of risky investments — so it may be even more painful to get out with few potential buyers able to absorb mass selling. “We think the market's telling you to upgrade your portfolio,” Mr. Cudzil said. “Whether it happens tomorrow or in six months, do you want look silly before the market sells off or after?”