| Abstract: |
Mutual funds' exposure to corporate bonds has brought concerns about risks
arising from liquidity transformation back to the fore. With a focus on fund
asset liquidity and investors, this paper explores the flow-performance
relationship and the liquidity management of funds in the presence of net
redemptions. We highlight the response of fund liquidity because the
vulnerability to outflows is found to depend on asset liquidity and fund
ownership. We construct a unique panel of German corporate bond funds by
merging data on asset liquidity with information on fund ownership. First,
conditional on underperformance, illiquid funds dominated by retail investors
are more exposed to outflows than illiquid funds primarily owned by
institutional investors. Large investors are reluctant to withdraw most likely
because they internalise the fire-sale-driven loss that a withdrawal inflicts
on an illiquid fund. Within institutional-oriented funds, the flow response to
bad performance is only significant if fund assets are sufficiently liquid.
Second, the way that fund managers liquidate their bonds to meet redemptions
is found to differ across ownership structures and depends on the degree of
macroeconomic uncertainty: in times of high uncertainty, managers of
institutional-oriented funds sell bonds in a liquidity pecking order style,
thereby preserving short-term performance. At the same time, retail-based
funds do not let portfolio liquidity deteriorate - presumably to attenuate
incentives for runs. |