Investor Flows and Fragility in Corporate Bond Funds

Abstract

Investment in bond mutual funds has grown rapidly in recent years. With it, there is a growing concern that they are a new source of potential fragility. While there is a vast literature on flows in equity mutual funds, relatively little research has been done on bond mutual funds. In this paper, we explore flow patterns in corporate-bond mutual funds. We show that their flows behave quite differently than those of equity mutual funds. While we confirm the well-known convex shape for equity funds’ flow-to-performance over the period of our study (1992-2014), we show that during the same time, corporate bond funds exhibit no convexity. Under some performance benchmarks, corporate bond funds even exhibit a concave shape: their outflows are sensitive to bad performance more than their inflows are sensitive to good performance. Moreover, corporate bond funds tend to have more concave flow-performance relationships when they have more illiquid assets and when the overall market illiquidity is high. These results point to the possibility of fragility: The illiquidity of corporate bonds may generate a first mover advantage (or strategic complementarities) among investors in corporate-bond funds, amplifying their response to bad performance or other bad news.