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Mutual Fund Liquidity Transformation
and Reverse Flight to Liquidity
Yiming Ma
Columbia GSB
Kairong Xiao
Columbia GSB
Yao Zeng
Wharton
2020 Financial Stability Conference
November 2020
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 1
Motivation
I Covid-19 crisis: traditionally liquid assets became strained
from unusually high selling pressures
I e.g. Haddad, Moreira, and Muir 20; Due 20; He, Nagel, and
Song 20; Kargar et al. 20
I Reverse ight to liquidity
I Conventional wisdom: ight to liquidity during market
distress
I high buying pressure for liquid assets
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 2
Heightened Selling Pressure in Treasury Market
-.4
-.3
-.2
-.1
0
.1
US
Treasury
CDS-adjusted
adjusted
swap
spreads
(%)
Jan Feb Mar Apr May
Treasury discount ↓
= Interest swap yield + Treasury CDS - Treasury yield ↑
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 3
Motivation
I The conventional negative correlation between Treasury yield
and VIX is reversed in Covid-19 crisis
Figure: Treasury Yields and VIX in Jan-Apr 2020
01-02
01-03
01-06
01-07
01-08
01-09
01-10
01-13
01-14
01-15
01-16
01-17
01-21
01-22
01-23
01-24
01-27
01-28
01-29
01-30
01-31
02-03
02-04
02-05
02-06
02-07
02-10
02-11
02-12
02-13
02-14
02-18
02-19
02-20
02-21
02-24
02-25
02-26 02-27
02-28
03-02
03-03
03-04
03-05
03-06
03-09
03-10 03-11
03-12
03-13
03-16
03-17
03-18
03-19
03-20
03-23
03-24
03-25
03-26
03-27
03-30
03-31
04-01
04-02
04-03
04-06
04-07
04-08
04-09
04-13
04-14
04-15
04-16
04-17
04-20
04-21
04-22
04-23
04-24
04-27
04-28
04-29
04-30
1
1.5
2
2.5
30-year
Treasury
yield
(%)
20 40 60 80
VIX
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 4
Motivation
I Conventional wisdom: ight to liquidity
Figure: Treasury Yields and VIX in Aug-Sep 2008
08-01
08-04
08-05
08-06
08-07
08-08
08-11
08-12
08-13
08-14
08-15
08-18
08-19
08-20
08-21
08-22
08-25
08-26
08-27
08-28
08-29
09-02
09-03
09-04
09-05
09-08
09-09
09-10
09-11
09-12
09-15
09-16 09-17
09-18
09-19
09-22
09-23
09-24
09-25
09-26
09-29
09-30
4
4.2
4.4
4.6
4.8
30-year
Treasury
yield
(%)
20 30 40 50
VIX
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 5
Heightened Selling Pressure in IG Corp Bonds
-4
-3
-2
-1
0
CDS-bond
basis
(%)
Jan Feb Mar Apr May
IG HY
CDS-bond basis ↓
= corporate bond CDS spread ↑ - corporate bond spread ↑↑↑
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 6
Motivation
The market for U.S. Treasuries has long been viewed as the
world's most liquid nancial market. That presumption was
questioned...
Still the World's Safe Haven? Darrel Due
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 7
What caused the reverse ight to liquidity phenomenon?
I Bond mutual funds
I Liquidity transformation → large redemption in crisis
I Pecking order of liquidation → concentrated sale of liquid
assets
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 8
What caused the reverse ight to liquidity phenomenon?
I Bond mutual funds
I Liquidity transformation → large redemption in crisis
I Pecking order of liquidation → concentrated sale of liquid
assets
I Implications of the reverse ight to liquidity phenomenon
I With more liquidity transformation by bond funds
I Liquid assets may experience more volatility
I May steer central banks towards providing liquidity backstops
to bond funds
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 8
Literature
1. Disruptions in liquid asset market during Covid-19
I Haddad, Moreira, and Muir 20 and Kargar et al. 20: document
debt market disruptions
I Due 20, He, Nagel, and Song 20: dealer constraints
I Falato, Goldstein and Hortacsu 20: fragility in fund ows
I A new explanation for heightened selling pressure in liquid assets
through mutual fund liquidity transformation
2. Financial intermediation by banks versus non-banks
I E.g. Diamond and Dybvig 83, Goldstein and Pozner 05, Hanson,
Shleifer, Stein, and Vishny 15, Ma, Xiao, and Zeng 20
I Asset-side implications of liquidity provision by mutual funds
versus banks
3. Mutual fund ows and nancial stability
I E.g. Chen, Goldstein, and Jiang 10, Goldstein, Jiang, and Ng 17,
Chernenko and Sunderam 17, Jiang, Li, and Wang 20
I ↑ fund asset illiquidity → ↑ potential for liquid asset market
disruptions
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 9
Roadmap
1. Aggregate Trends
2. Empirical Evidence
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 10
Bond Fund Growth
I Bond mutual funds have become increasingly important...
Total Assets
0
1000
2000
3000
4000
5000
Fund
assets
(billion)
1995 2000 2005 2010 2015 2020
Fund Shares/Deposits
.15
.2
.25
.3
.35
Fixed-income
fund
shares
/
Bank
deposits
1995 2000 2005 2010 2015 2020
I AUM: $1 trillion to $4.5 trillion from 2007 to 2019
I Shares/Deposits: 0.22 to 0.35 from 2007 to 2019
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 11
Mutual Fund Liquidity Transformation
Bank
Illiquid assets
Liquid assets
Demandable debt
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 12
Mutual Fund Liquidity Transformation
Bank
Illiquid assets
Liquid assets
Demandable debt
Bond funds
Illiquid assets
Liquid assets
Demandable equity
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 12
Mutual Fund Liquidity Transformation
Bank
Illiquid assets
Liquid assets
Demandable debt
Bond funds
Illiquid assets
Liquid assets
Demandable equity
I Like banks, bond funds provide liquidity by issuing liquid
claims backed by (mostly) illiquid assets
I Liquidity transformation may lead to rst-mover advantage,
e.g. Market value drops from 100 to 80 but NAV is still at 90
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 12
Pronounced Outows at Bond Funds
I Bond funds suered an unprecedented $264 billion outows in
March, 2020
Bond funds
-300
-200
-100
0
100
Fund
flows
(billion)
2000 2005 2010 2015 2020
Equity funds
-300
-200
-100
0
100
Fund
flows
(billion) 2000 2005 2010 2015 2020
I Equity funds suered much smaller outows → liquidity
transformation must matter...
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 13
Higher Asset Illiquidity, Larger Outows
I ...also evident from more pronounced outows at more illiquid
bond funds
-20
-10
0
10
Cummulative
fund
flows
(%
AUM)
Jan2020 Feb2020 Mar2020 Apr2020 May2020
Government Investment grade
High yield Loan
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 14
Concentrated Sales of Liquid Assets
I Liquid assets were disproportionately liquidated
-10
-5
0
Position
change
(%)
CCC-
CCC-
CCC
CCC+
B-
B
B+
BB-
BB
BB+
BBB-
BBB
BBB+
A-
A
A+
AA-
AA
AA+
AAA
Treasury
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 15
Large Aggregate Liquidations
I Aggregate Treasury liquidations by open-end funds amounted
to $236 billion in 2020Q1
-300 -100 100 300
Change in Treasuries (billion)
Money market funds
ETFs
Insurance companies
Nonfinancial business
GSEs
Banks
Closed-end funds
ABS
Credit unions
Pension funds
Foreign banking offices in U.S.
Broker dealers
Households
Mutual funds
Rest of the world
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 16
Empirical Evidence
Liquidity Transformation and Outows: Fund-level Evidence
Figure: Fund Outows versus Fund Liquidity Provision Index (LPI)
0
2
4
6
Fund
outflows
0 2 4 6 8
Liquidity Provision Index (LPI)
I LPI = per dollar expected contract payment - direct
liquidation value assets (Ma, Xiao and Zeng 19)
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 17
Cross-section Determinants of Outows
I High asset illiquidity → more outows
(1) (2) (3) (4)
Outow Outow Outow Outow
Fund illiquidity 0.546∗∗∗ 0.545∗∗∗ 0.537∗∗∗ 0.564∗∗∗
[0.092] [0.092] [0.094] [0.096]
Institutional 0.137 0.135 0.283
[0.203] [0.203] [0.204]
Index fund -0.259 -0.614
[0.595] [0.602]
Fund objective F.E. No No No Yes
Observations 6,355 6,355 6,355 6,355
Adj. R-squared 0.005 0.005 0.005 0.021
I Other controls: yield, return volatility, expense ratio, turnover
ratio
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 18
What did funds sell when they face redemption?
Reverse Flight to Liquidity: Pecking Order
Liquidationsi,j = βFund Outowj + γXi + θXj + i,j
Figure: Liquidation to Redemption Sensitivity by Bond Rating
-.5
0
.5
1
1.5
2
CCC-
CCC-
CCC
CCC+
B-
B
B+
BB-
BB
BB+
BBB-
BBB
BBB+
A-
A
A+
AA-
AA
AA+
AAA
Treasury
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 19
Pecking Order based on Relative Liquidity: Measure
Ranki,j =
X
i0
Sharei0,j × 1[Liquidityi  Liquidityi0 ]
I Ranki,j is dened as the sum of shares of assets held by fund j
that are less liquid than bond i
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 20
Pecking Order based on Relative Liquidity: An Example
I Compare two identical Treasury bonds held by (1) a Treasury
fund and (2) a corporate bond fund
I Treasury bond fund has more liquid assets → ranked lower in
the pecking order
I Corporate bond fund has more illiquid assets → ranked higher
in the pecking order
I Corporate bond fund is more likely to sell the Treasury bond
for the same redemption
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 21
Reverse Flight to Liquidity: Pecking Order
Liquidationi,j = βOutowsj × Ranki,j + γXi,j + i,j
(1) (2) (3)
Open-end
All
Open-end
Active
Open-end
Passive
Outows 0.268∗∗∗
0.208∗∗∗
0.224∗∗∗
[0.016] [0.024] [0.035]
Outows*Rank 0.198∗∗∗
0.386∗∗∗
0.082
[0.047] [0.060] [0.151]
Bond F.E. Yes Yes Yes
Fund objective F.E. Yes Yes Yes
Observations 79,050 37,945 39,410
Adj. R-squared 0.067 0.071 0.050
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 22
Did funds' selling pressure aect prices of liquid
assets?
Bond yields by liquidation rank
Figure: Pecking order of liquidation and bond yield
-40
-20
0
20
40
Yield
(bps)
Feb Mar Apr May
Q1 Q2
Q3 Q4
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 23
Impact on Asset Prices
Imputed Outowi,t =
X
j
Fund outowj,t ×
Holdingi,j,2019Q4
P
k Holdingi,k,2019Q4
Returni,t = βImputed Outowi,t × High ranki + γXi,t + i,t
(1) (2) (3)
Return Return Return
Outows -1.646 -1.741 -1.856
[1.167] [1.174] [1.194]
Outows*High rank -3.443∗∗ -3.550∗∗ -3.506∗∗
[1.426] [1.433] [1.459]
Rating-Time F.E. Yes No No
Maturity-Time F.E. Yes No No
Issuer F.E. No Yes Yes
Bond F.E. No No Yes
Observations 398,678 398,678 398,677
Adj. R-squared 0.174 0.175 0.166
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 24
What were the eects of Fed interventions ?
Fed Intervention
Unprecedented intervention by the Fed in xed income markets:
I March 15: Announced purchase of Treasuries
I March 23: Announced purchase of IG corporate bonds
I April 9: Announced extension of corporate bond purchase
I Larger volume
I Include fallen angels
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 25
Eect of Fed Interventions on Fund Flows
Outflowsi,t = βFedInterventiont + γXi,t + i,t
(1) (2) (3) (4)
Govt IG HY BL
Treasury bond purchase 0.014 0.043 0.093∗∗∗
0.093∗∗∗
[0.032] [0.039] [0.026] [0.033]
Corp bond purchase 0.217∗∗∗
0.366∗∗∗
-0.057 0.161∗∗∗
[0.040] [0.063] [0.035] [0.051]
Corp bond purchase expansion 0.057∗∗∗
-0.039∗∗
-0.069∗∗∗
-0.073∗∗∗
[0.017] [0.019] [0.008] [0.010]
Control Yes Yes Yes Yes
Fund xed eects Yes Yes Yes Yes
Month xed eects Yes Yes Yes Yes
Observations 13,573 6,452 17,819 9,364
Adj. R-squared 0.058 0.071 0.067 0.096
I Announcements of corp bond purchase stopped outows, but Treasury
bond purchase did not
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 26
Eect of Fed Interventions on Fund NAV
∆NAVi,t = βFedInterventiont + γXi,t + i,t
(1) (2) (3) (4)
Govt IG HY BL
Treasury bond purchase 0.241∗∗
0.188 -2.336∗∗∗
-2.618∗∗∗
[0.119] [0.236] [0.274] [0.290]
Corp bond purchase 0.901∗∗∗
0.866∗∗
-1.261∗∗
-1.941∗∗∗
[0.178] [0.400] [0.486] [0.487]
Corp bond purchase expansion 0.399∗∗∗
1.616∗∗∗
1.621∗∗∗
1.114∗∗∗
[0.039] [0.066] [0.111] [0.095]
Control Yes Yes Yes Yes
Fund xed eects Yes Yes Yes Yes
Month xed eects Yes Yes Yes Yes
Observations 13,565 6,451 17,816 9,357
Adj. R-squared 0.180 0.427 0.323 0.377
I Announcements of corp bond purchase increased NAVs, but Treasury
bond purchase did not
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 27
Why did reverse ight to liquidity emerge this time?
I Increased liquidity transformation by funds since last crisis
I Bond fund AUM: $1 trillion to $4.5 trillion from 2007 to 2019
I With increased mutual fund liquidity transformation, going
forward:
I Increased volatility in traditionally liquid assets
I Are US Treasury Bonds Still a Safe Haven? (He and
Krishnamurthy, 2020)
I Mutual funds conduct liquidity transformation outside public
liquidity backstops
I More reliance on unconventional central bank asset purchases
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 28
Conclusion
1. What caused the reverse ight to liquidity phenomenon?
Mutual funds transform liquidity by issuing demandable equity
shares + using pecking order of liquidations
2. What are the policy eects?
The purchase of illiquid assets directly alleviates fund outows
and is more eective than the purchase of liquid assets
3. What was special about the Covid-19 crisis? Could everything
happen again in the future?
Migration of liquidity transformation to mutual funds
Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 29

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Kairong Xiao Presentation (1).pdf

  • 1. Mutual Fund Liquidity Transformation and Reverse Flight to Liquidity Yiming Ma Columbia GSB Kairong Xiao Columbia GSB Yao Zeng Wharton 2020 Financial Stability Conference November 2020 Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 1
  • 2. Motivation I Covid-19 crisis: traditionally liquid assets became strained from unusually high selling pressures I e.g. Haddad, Moreira, and Muir 20; Due 20; He, Nagel, and Song 20; Kargar et al. 20 I Reverse ight to liquidity I Conventional wisdom: ight to liquidity during market distress I high buying pressure for liquid assets Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 2
  • 3. Heightened Selling Pressure in Treasury Market -.4 -.3 -.2 -.1 0 .1 US Treasury CDS-adjusted adjusted swap spreads (%) Jan Feb Mar Apr May Treasury discount ↓ = Interest swap yield + Treasury CDS - Treasury yield ↑ Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 3
  • 4. Motivation I The conventional negative correlation between Treasury yield and VIX is reversed in Covid-19 crisis Figure: Treasury Yields and VIX in Jan-Apr 2020 01-02 01-03 01-06 01-07 01-08 01-09 01-10 01-13 01-14 01-15 01-16 01-17 01-21 01-22 01-23 01-24 01-27 01-28 01-29 01-30 01-31 02-03 02-04 02-05 02-06 02-07 02-10 02-11 02-12 02-13 02-14 02-18 02-19 02-20 02-21 02-24 02-25 02-26 02-27 02-28 03-02 03-03 03-04 03-05 03-06 03-09 03-10 03-11 03-12 03-13 03-16 03-17 03-18 03-19 03-20 03-23 03-24 03-25 03-26 03-27 03-30 03-31 04-01 04-02 04-03 04-06 04-07 04-08 04-09 04-13 04-14 04-15 04-16 04-17 04-20 04-21 04-22 04-23 04-24 04-27 04-28 04-29 04-30 1 1.5 2 2.5 30-year Treasury yield (%) 20 40 60 80 VIX Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 4
  • 5. Motivation I Conventional wisdom: ight to liquidity Figure: Treasury Yields and VIX in Aug-Sep 2008 08-01 08-04 08-05 08-06 08-07 08-08 08-11 08-12 08-13 08-14 08-15 08-18 08-19 08-20 08-21 08-22 08-25 08-26 08-27 08-28 08-29 09-02 09-03 09-04 09-05 09-08 09-09 09-10 09-11 09-12 09-15 09-16 09-17 09-18 09-19 09-22 09-23 09-24 09-25 09-26 09-29 09-30 4 4.2 4.4 4.6 4.8 30-year Treasury yield (%) 20 30 40 50 VIX Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 5
  • 6. Heightened Selling Pressure in IG Corp Bonds -4 -3 -2 -1 0 CDS-bond basis (%) Jan Feb Mar Apr May IG HY CDS-bond basis ↓ = corporate bond CDS spread ↑ - corporate bond spread ↑↑↑ Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 6
  • 7. Motivation The market for U.S. Treasuries has long been viewed as the world's most liquid nancial market. That presumption was questioned... Still the World's Safe Haven? Darrel Due Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 7
  • 8. What caused the reverse ight to liquidity phenomenon? I Bond mutual funds I Liquidity transformation → large redemption in crisis I Pecking order of liquidation → concentrated sale of liquid assets Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 8
  • 9. What caused the reverse ight to liquidity phenomenon? I Bond mutual funds I Liquidity transformation → large redemption in crisis I Pecking order of liquidation → concentrated sale of liquid assets I Implications of the reverse ight to liquidity phenomenon I With more liquidity transformation by bond funds I Liquid assets may experience more volatility I May steer central banks towards providing liquidity backstops to bond funds Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 8
  • 10. Literature 1. Disruptions in liquid asset market during Covid-19 I Haddad, Moreira, and Muir 20 and Kargar et al. 20: document debt market disruptions I Due 20, He, Nagel, and Song 20: dealer constraints I Falato, Goldstein and Hortacsu 20: fragility in fund ows I A new explanation for heightened selling pressure in liquid assets through mutual fund liquidity transformation 2. Financial intermediation by banks versus non-banks I E.g. Diamond and Dybvig 83, Goldstein and Pozner 05, Hanson, Shleifer, Stein, and Vishny 15, Ma, Xiao, and Zeng 20 I Asset-side implications of liquidity provision by mutual funds versus banks 3. Mutual fund ows and nancial stability I E.g. Chen, Goldstein, and Jiang 10, Goldstein, Jiang, and Ng 17, Chernenko and Sunderam 17, Jiang, Li, and Wang 20 I ↑ fund asset illiquidity → ↑ potential for liquid asset market disruptions Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 9
  • 11. Roadmap 1. Aggregate Trends 2. Empirical Evidence Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 10
  • 12. Bond Fund Growth I Bond mutual funds have become increasingly important... Total Assets 0 1000 2000 3000 4000 5000 Fund assets (billion) 1995 2000 2005 2010 2015 2020 Fund Shares/Deposits .15 .2 .25 .3 .35 Fixed-income fund shares / Bank deposits 1995 2000 2005 2010 2015 2020 I AUM: $1 trillion to $4.5 trillion from 2007 to 2019 I Shares/Deposits: 0.22 to 0.35 from 2007 to 2019 Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 11
  • 13. Mutual Fund Liquidity Transformation Bank Illiquid assets Liquid assets Demandable debt Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 12
  • 14. Mutual Fund Liquidity Transformation Bank Illiquid assets Liquid assets Demandable debt Bond funds Illiquid assets Liquid assets Demandable equity Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 12
  • 15. Mutual Fund Liquidity Transformation Bank Illiquid assets Liquid assets Demandable debt Bond funds Illiquid assets Liquid assets Demandable equity I Like banks, bond funds provide liquidity by issuing liquid claims backed by (mostly) illiquid assets I Liquidity transformation may lead to rst-mover advantage, e.g. Market value drops from 100 to 80 but NAV is still at 90 Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 12
  • 16. Pronounced Outows at Bond Funds I Bond funds suered an unprecedented $264 billion outows in March, 2020 Bond funds -300 -200 -100 0 100 Fund flows (billion) 2000 2005 2010 2015 2020 Equity funds -300 -200 -100 0 100 Fund flows (billion) 2000 2005 2010 2015 2020 I Equity funds suered much smaller outows → liquidity transformation must matter... Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 13
  • 17. Higher Asset Illiquidity, Larger Outows I ...also evident from more pronounced outows at more illiquid bond funds -20 -10 0 10 Cummulative fund flows (% AUM) Jan2020 Feb2020 Mar2020 Apr2020 May2020 Government Investment grade High yield Loan Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 14
  • 18. Concentrated Sales of Liquid Assets I Liquid assets were disproportionately liquidated -10 -5 0 Position change (%) CCC- CCC- CCC CCC+ B- B B+ BB- BB BB+ BBB- BBB BBB+ A- A A+ AA- AA AA+ AAA Treasury Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 15
  • 19. Large Aggregate Liquidations I Aggregate Treasury liquidations by open-end funds amounted to $236 billion in 2020Q1 -300 -100 100 300 Change in Treasuries (billion) Money market funds ETFs Insurance companies Nonfinancial business GSEs Banks Closed-end funds ABS Credit unions Pension funds Foreign banking offices in U.S. Broker dealers Households Mutual funds Rest of the world Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 16
  • 21. Liquidity Transformation and Outows: Fund-level Evidence Figure: Fund Outows versus Fund Liquidity Provision Index (LPI) 0 2 4 6 Fund outflows 0 2 4 6 8 Liquidity Provision Index (LPI) I LPI = per dollar expected contract payment - direct liquidation value assets (Ma, Xiao and Zeng 19) Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 17
  • 22. Cross-section Determinants of Outows I High asset illiquidity → more outows (1) (2) (3) (4) Outow Outow Outow Outow Fund illiquidity 0.546∗∗∗ 0.545∗∗∗ 0.537∗∗∗ 0.564∗∗∗ [0.092] [0.092] [0.094] [0.096] Institutional 0.137 0.135 0.283 [0.203] [0.203] [0.204] Index fund -0.259 -0.614 [0.595] [0.602] Fund objective F.E. No No No Yes Observations 6,355 6,355 6,355 6,355 Adj. R-squared 0.005 0.005 0.005 0.021 I Other controls: yield, return volatility, expense ratio, turnover ratio Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 18
  • 23. What did funds sell when they face redemption?
  • 24. Reverse Flight to Liquidity: Pecking Order Liquidationsi,j = βFund Outowj + γXi + θXj + i,j Figure: Liquidation to Redemption Sensitivity by Bond Rating -.5 0 .5 1 1.5 2 CCC- CCC- CCC CCC+ B- B B+ BB- BB BB+ BBB- BBB BBB+ A- A A+ AA- AA AA+ AAA Treasury Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 19
  • 25. Pecking Order based on Relative Liquidity: Measure Ranki,j = X i0 Sharei0,j × 1[Liquidityi Liquidityi0 ] I Ranki,j is dened as the sum of shares of assets held by fund j that are less liquid than bond i Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 20
  • 26. Pecking Order based on Relative Liquidity: An Example I Compare two identical Treasury bonds held by (1) a Treasury fund and (2) a corporate bond fund I Treasury bond fund has more liquid assets → ranked lower in the pecking order I Corporate bond fund has more illiquid assets → ranked higher in the pecking order I Corporate bond fund is more likely to sell the Treasury bond for the same redemption Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 21
  • 27. Reverse Flight to Liquidity: Pecking Order Liquidationi,j = βOutowsj × Ranki,j + γXi,j + i,j (1) (2) (3) Open-end All Open-end Active Open-end Passive Outows 0.268∗∗∗ 0.208∗∗∗ 0.224∗∗∗ [0.016] [0.024] [0.035] Outows*Rank 0.198∗∗∗ 0.386∗∗∗ 0.082 [0.047] [0.060] [0.151] Bond F.E. Yes Yes Yes Fund objective F.E. Yes Yes Yes Observations 79,050 37,945 39,410 Adj. R-squared 0.067 0.071 0.050 Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 22
  • 28. Did funds' selling pressure aect prices of liquid assets?
  • 29. Bond yields by liquidation rank Figure: Pecking order of liquidation and bond yield -40 -20 0 20 40 Yield (bps) Feb Mar Apr May Q1 Q2 Q3 Q4 Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 23
  • 30. Impact on Asset Prices Imputed Outowi,t = X j Fund outowj,t × Holdingi,j,2019Q4 P k Holdingi,k,2019Q4 Returni,t = βImputed Outowi,t × High ranki + γXi,t + i,t (1) (2) (3) Return Return Return Outows -1.646 -1.741 -1.856 [1.167] [1.174] [1.194] Outows*High rank -3.443∗∗ -3.550∗∗ -3.506∗∗ [1.426] [1.433] [1.459] Rating-Time F.E. Yes No No Maturity-Time F.E. Yes No No Issuer F.E. No Yes Yes Bond F.E. No No Yes Observations 398,678 398,678 398,677 Adj. R-squared 0.174 0.175 0.166 Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 24
  • 31. What were the eects of Fed interventions ?
  • 32. Fed Intervention Unprecedented intervention by the Fed in xed income markets: I March 15: Announced purchase of Treasuries I March 23: Announced purchase of IG corporate bonds I April 9: Announced extension of corporate bond purchase I Larger volume I Include fallen angels Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 25
  • 33. Eect of Fed Interventions on Fund Flows Outflowsi,t = βFedInterventiont + γXi,t + i,t (1) (2) (3) (4) Govt IG HY BL Treasury bond purchase 0.014 0.043 0.093∗∗∗ 0.093∗∗∗ [0.032] [0.039] [0.026] [0.033] Corp bond purchase 0.217∗∗∗ 0.366∗∗∗ -0.057 0.161∗∗∗ [0.040] [0.063] [0.035] [0.051] Corp bond purchase expansion 0.057∗∗∗ -0.039∗∗ -0.069∗∗∗ -0.073∗∗∗ [0.017] [0.019] [0.008] [0.010] Control Yes Yes Yes Yes Fund xed eects Yes Yes Yes Yes Month xed eects Yes Yes Yes Yes Observations 13,573 6,452 17,819 9,364 Adj. R-squared 0.058 0.071 0.067 0.096 I Announcements of corp bond purchase stopped outows, but Treasury bond purchase did not Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 26
  • 34. Eect of Fed Interventions on Fund NAV ∆NAVi,t = βFedInterventiont + γXi,t + i,t (1) (2) (3) (4) Govt IG HY BL Treasury bond purchase 0.241∗∗ 0.188 -2.336∗∗∗ -2.618∗∗∗ [0.119] [0.236] [0.274] [0.290] Corp bond purchase 0.901∗∗∗ 0.866∗∗ -1.261∗∗ -1.941∗∗∗ [0.178] [0.400] [0.486] [0.487] Corp bond purchase expansion 0.399∗∗∗ 1.616∗∗∗ 1.621∗∗∗ 1.114∗∗∗ [0.039] [0.066] [0.111] [0.095] Control Yes Yes Yes Yes Fund xed eects Yes Yes Yes Yes Month xed eects Yes Yes Yes Yes Observations 13,565 6,451 17,816 9,357 Adj. R-squared 0.180 0.427 0.323 0.377 I Announcements of corp bond purchase increased NAVs, but Treasury bond purchase did not Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 27
  • 35. Why did reverse ight to liquidity emerge this time? I Increased liquidity transformation by funds since last crisis I Bond fund AUM: $1 trillion to $4.5 trillion from 2007 to 2019 I With increased mutual fund liquidity transformation, going forward: I Increased volatility in traditionally liquid assets I Are US Treasury Bonds Still a Safe Haven? (He and Krishnamurthy, 2020) I Mutual funds conduct liquidity transformation outside public liquidity backstops I More reliance on unconventional central bank asset purchases Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 28
  • 36. Conclusion 1. What caused the reverse ight to liquidity phenomenon? Mutual funds transform liquidity by issuing demandable equity shares + using pecking order of liquidations 2. What are the policy eects? The purchase of illiquid assets directly alleviates fund outows and is more eective than the purchase of liquid assets 3. What was special about the Covid-19 crisis? Could everything happen again in the future? Migration of liquidity transformation to mutual funds Yiming Ma Kairong Xiao Yao Zeng Mutual Funds and Reverse Flight to Liquidity 29