Investor Redemptions Research Articles

Green credit policy and the net value crash risks of fund holding heavily polluting enterprise stocks: a quasi-natural experiment.

Based on the data of China's open-end stock funds and partial stock funds from 2009 to 2020, we take the implementation of green credit guidelines (GCG) as a quasi-natural experiment and investigate the impact of green credit policies on the net value crash risks of fund holding heavily polluting enterprise stocks. The results show that green credit policies will significantly increase the net value crash risks of fund holding heavily polluting enterprise stocks. Green credit policies increase the net value crash risks of fund holding heavily polluting enterprise stocks by increasing investor redemptions. Further tests show that better fund performance and higher portfolio concentration weaken the positive impact of green credit policies on the net value crash risks of fund holding heavily polluting enterprise stocks, and higher proportion of institutional investors strengthens the positive impact of green credit policies on the net value crash risks of fund holding heavily polluting enterprise stocks. This study supplements the literature on green credit policies and funds, and provides policy guidance for regulators.

Redemption in Kind and Mutual Fund Liquidity Management

Abstract Open-end mutual funds can use redemption in kind to satisfy investor redemptions by delivering securities instead of cash. We find that funds that reserve their rights to redeem in kind experience less redemption after poor performance. Evidence from actual in-kind transactions reveals several unique mechanisms for redemption in kind to mitigate fund runs, including the delivery of more illiquid stocks and stocks with greater tax overhang. Funds suffer less from the adverse impact of outflows on their performance. However, redeeming investors bear significant liquidation costs when they sell securities, costs associated with destabilization in the prices of these securities. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Meeting investor outflows in Czech bond and equity funds: horizontal or vertical?

This paper explores liquidity management practices in Czech open-ended bond and equity funds. I reconstruct cash flows stemming from investors and securities, and cash flows related to purchases and sales in portfolios and margin calls to study liquidity transformation and liquidity management in investment funds. I study how portfolio illiquidity and current market conditions influence the joint behavior between investor redemptions and funds’ liquidity management. I point to a strong propensity to reduce the liquid buffers rather than sales of securities to meet redemptions in bond funds. The propensity increases with portfolio illiquidity. I show equity funds historically tended to dash for cash in response to investor redemptions during a severe market turmoil.

Fire‐Sale Spillovers in Debt Markets

ABSTRACTFire sales induced by investor redemptions have powerful spillover effects among funds that hold the same assets, hurting peer funds' performance and flows, and leading to further asset sales with negative bond price impact. A one‐standard‐deviation increase in our fire‐sale spillover measure leads to a 45 (90) bp decrease in peer fund returns (flows) and a two percentage point increase in the likelihood of a large bond price drop. The results hold in a regression‐discontinuity design addressing identification concerns. Timing, heterogeneity, instrumental‐variable, and placebo tests further support the price‐impact mechanism. Model‐based counterfactual and stress‐test analyses quantify the financial stability implications.

Liquidity Management and Asset Sales by Bond Funds in the Face of Investor Redemptions in March 2020

Investor redemptions are one factor behind asset sales by open-ended mutual funds, but an important additional factor is the selling due to the funds' liquidity management. Funds holding illiquid assets reacted to redemptions in March 2020 by adding to their cash buffers even after meeting investor redemptions. For such funds, asset sales exceeded investor redemptions. Increases in end-of-period cash holdings were less pronounced for funds that started the stress period with larger buffers, suggesting that such funds were less prone to selling at the height of the stress.

Carbon Emissions, Institutional Trading, and the Liquidity of Corporate Bonds

This paper provides a detailed investigation on how firms’ carbon emission levels affect institutional investors’ trading behaviors and liquidity conditions of corporate bonds. Our analysis is conducted with a full sample from 2007 to 2019 and causality is further established by exploiting two carbon-related shocks: The Paris Agreement and the election of U.S. President Trump. We find that both mutual funds and insurance companies are more likely to sell corporate bonds in herds if the bonds’ issuing firms have higher carbon emissions. We show that mutual fund flows negatively respond to the fund’s carbon exposures and that mutual funds are more likely to sell high-carbon bonds in the face of investor redemptions. We also find that bonds issued by high-emission firms experience worse liquidity conditions.

Valuation discrepancies in money market funds during market disruptions: evidence from Egypt

Money market funds (MMFs) are generally considered safe investment vehicles, but the 2008 global financial crisis showed their vulnerability during market disruptions resulting in increased regulatory oversight across developed markets to protect investors. This paper examines the effect of MMF accounting regulation on investors in an emerging market context. It hypothesizes that the continued use of amortized cost methods to account for MMFs’ Net Asset Value (NAV) during market disruptions can result in unfair treatment of investors. The Egyptian money market provided a unique laboratory to test this hypothesis over a prominent economic crisis that combined high levels of interest rate volatility with a redemption-only structure for MMFs. A model that measures the discrepancies between the amortized and floating market NAVs per certificate for various money market portfolios (MMPs) simulating MMFs of different durations is tested using the Egyptian data. A sharp rise in interest rates is found to lead to significant discrepancies between the amortized NAV per certificate relative to their floating value. Serial investor redemptions of the certificates compound the discrepancies, but only certificate holders remaining in the funds bear the accumulated losses, which are augmented for portfolios with higher durations. The results suggest that emerging market regulators consider introducing the rules that switch to floating NAV calculations for MMFs during such periods to promote equality across all investors.

Fire sales by euro area banks and funds: What is their asset price impact?

The assets under management of investment funds have soared in recent years, triggering a debate on their possible implications for financial stability. We contribute to this debate assessing the asset price impact of fire sales in a novel partial equilibrium model of euro area funds and banks calibrated over the period between 2008 and 2017. An initial shock to yields causes funds to sell assets to address investor redemptions, while both banks and funds sell assets to keep their leverage constant. These fire sales generate second-round price effects. We find that the potential losses due to the price impact of fire sales have decreased over time for the system. The contribution of funds to this impact is lower than that of banks. However, funds’ relative contribution has risen due to their increased assets under management and banks’ lower leverage and rebalancing towards loans. Should this trend continue, funds will become an increasingly important source of systemic risk.

Dynamic Liquidity Management by Corporate Bond Mutual Funds

AbstractHow do corporate bond mutual funds manage liquidity to meet investor redemptions? We show that during tranquil market conditions, these funds tend to reduce liquid asset holdings to meet redemptions, temporarily increasing relative exposures to illiquid asset classes. When aggregate uncertainty rises, however, they tend to scale down their liquid and illiquid assets proportionally to preserve portfolio liquidity. This fund-level dynamic management of liquidity appears to affect the broad financial market: Redemptions from the corporate bond fund sector lead to more corporate bond selling during high-uncertainty periods, which generates price pressures and predicts strong return reversals.

Redemption in Kind and Mutual Fund Liquidity Management

Open-end mutual funds can use redemption in kind to satisfy investor redemptions by delivering securities instead of cash. We find that funds that reserve their rights to redeem in kind experience less redemption after poor performance. Evidence from actual in-kind transactions reveals several unique mechanisms for redemption in kind to mitigate fund runs, including the delivery of more illiquid stocks and stocks with greater tax overhang. Funds also suffer less from the adverse impact of outflows on their performance. On the other hand, redeeming investors bear significant liquidation costs when they are forced to sell securities on their own.

Modelling Fire Sale Contagion Across Banks and Non-banks

We study the impact of common asset holdings across different financial sectors on financial stability. In particular, we model indirect contagion via fire sales across UK banks and non-banks. Fire sales are triggered by different responses to a financial shock: banks and non unit-linked insurers are subject to regulatory constraints, while funds and unit-linked insurers are obliged to meet investor redemptions. We use our model to conduct a systemic stress simulation under different initial shock scenarios and institutions’ selling strategies. We find that performing a stress simulation that does not account for common asset holdings across multiple sectors can severely underestimate the fire sale losses in the financial system.We also show that a pro-rata liquidation strategy would result in a higher level of fire sale losses, but a waterfall strategy may produce a higher spill over effect for a passive institution (or a passive sector) that chooses not to liquidate any of its assets during distress.

Fire Sales by Euro Area Banks and Funds: What is Their Asset Price Impact?

The assets under management of investment funds have soared in recent years, triggering a debate on their possible implications for financial stability. We contribute to this debate assessing the asset price impact of fire sales in a novel partial equilibrium model of euro area funds and banks calibrated over the period between 2008 and 2017. An initial shock to yields causes funds to sell assets to address investor redemptions, while both banks and funds sell assets to keep their leverage constant. These fire sales generate second-round price effects. We find that the potential losses due to the price impact of fire sales have decreased over time for the system. The contribution of funds to this impact is lower than that of banks. However, funds’ relative contribution has risen due to their increased assets under management and banks’ lower leverage and rebalancing towards loans. Should this trend continue, funds will become an increasingly important source of systemic risk. JEL Classification: G1, G21, G23

Access to Safe Assets and Financial Stability

How does the access to safe assets affect the fragility and lending behavior of financial intermediaries? We develop a global-game model of investor redemptions from money market funds that hold safe assets and fund risky corporate borrowers. Using the 2013 U.S. debt limit episode and the Federal Reserve's Overnight Reverse Repurchase (ONRRP) facility as our empirical laboratory, we provide evidence consistent with the model's implications. In particular, access to a safe asset---the ONRRP---attenuates investor redemption incentives and allows money market mutual funds to maintain their lending to corporate borrowers. Overall, our results suggest that the public provision of a safe asset reduces intermediary fragility and increases lending to the real economy.

Investor Information Acquisition and Money Market Fund Risk Rebalancing during the 2011–2012 Eurozone Crisis*

Abstract We study investor redemptions and portfolio rebalancing decisions of prime money market mutual funds (MMFs) during the Eurozone crisis. We find that sophisticated investors selectively acquire information about MMFs’ risk exposures to Europe, which leads managers to withdraw funding from information-sensitive European issuers. That is, MMF managers, particularly those serving the most sophisticated investors, selectively adjust their portfolio risk exposures to avoid information-sensitive European risks, while maintaining or increasing risk exposures to other regions. This mechanism helps to explain the occurrence of selective “dry-ups” in debt markets where delegation is common and returns to information production are usually low. (JEL G01, G21, G23) Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Interfund Lending in Mutual Fund Families: Role in Liquidity Management

AbstractThe Investment Company Act of 1940 restricts interfund lending and borrowing within a mutual fund family, but families can apply for regulatory exemptions to participate in such transactions. We find that the monitoring mechanisms and investment restrictions influence the family’s decision to apply for the interfund lending programs. We document several benefits of such programs for equity funds. First, participating funds reduce cash holdings and increase investments in illiquid assets. Second, fund investors exhibit less run-like behavior. Third, it helps mitigate asset fire sales after extreme investor redemptions. Offsetting these benefits, money market funds in participating families experience investor outflows.Received May 26, 2018; editorial decision November 27, 2018 by Editor Itay Goldstein. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Investor Redemptions and Fund Manager Sales of Emerging Market Bonds: How Are They Related?*

Lending to emerging market economies (EMEs) through bond purchases has surged since 2009. What are the risks of a sudden stop? Bond mutual funds may curtail credit through two channels. The first is redemptions by ultimate investors. The second is additional discretionary sales by fund managers, over and above any sales implied by redemptions. In an empirical analysis of EME bond funds, we find that discretionary sales tend to reinforce the sales due to investor redemptions, and that 100 dollars' worth of bond sales due to investor redemptions is accompanied by roughly 10 dollars' worth of discretionary bond sales. We also find that 100 dollars' worth of EME international bond sales is associated with around 4 dollars' worth of valuation losses. Finally, a 1 percentage point increase in the yield of local currency bonds is associated with a 10% decline in the dollar value of bond holdings.

Redemption risk and cash hoarding by asset managers

Open-end mutual funds face investor redemptions, but the sale of the underlying assets depends on asset managers’ portfolio decisions. If asset managers use cash holdings as a buffer to meet redemptions, they can mitigate fire sales of the assets. If they hoard cash in response to redemptions, they will amplify fire sales. We present a global game model of investor runs and identify conditions under which asset managers hoard cash. In an empirical investigation of bond mutual funds, we find that cash hoarding is the rule rather than the exception, and that less liquid bond funds display stronger cash hoarding.

Is the Price Right? Swing Pricing and Investor Redemptions

How effective are available policy tools in managing liquidity risks in the mutual fund industry? We assess one such tool - swing pricing - which allows funds to adjust their settlement price in response to large net flows. Our empirical analysis exploits the fact that swing pricing is available to Luxembourg funds, but not yet to U.S. funds. We show that swing pricing dampens outflows in reaction to weak fund performance, but has a limited effect during stress episodes. Furthermore, swing pricing supports fund returns, while raising accounting volatility, and may lead to lower cash buffers.

Transparency, Investor Information Acquisition, and Money Market Fund Risk Rebalancing During the 2011-12 Eurozone Crisis

We study investor redemptions and portfolio rebalancing decisions of money market mutual funds (MMFs) during the Eurozone crisis. We exploit the multiple share class structure of the MMF industry and the detailed portfolio holdings disclosure required by 2010 regulatory changes to highlight costs and benefits of increased transparency in short-term funding markets. Consistent with theoretical predictions of models featuring costly (and incomplete) information acquisition, investors with the lowest information acquisition costs are most responsive to cross-sectional heterogeneity in funds' exposures to Eurozone securities. Moreover, managers catering to these investors disproportionately shift their portfolios away from the riskiest and most information-sensitive securities.

Dynamic Liquidity Management by Corporate Bond Mutual Funds

This paper explores dynamic liquidity management by 578 open-end corporate bond funds during the period from 2002 to 2014. We find that during tranquil markets, managers of corporate bond funds tend to reduce their holdings of liquid assets such as cash and government bonds to meet investor redemptions, engaging in a “horizontal cut” of their asset allocations along the liquidity spectrum. During periods with heightened macroeconomic uncertainty, however, managers tend to liquidate relatively proportionally across asset classes, pursuing a “vertical cut” and maintaining portfolio liquidity. Consistent with the existence of a target ratio of liquid assets, we find that managers tend to sell illiquid assets to restore their holdings of liquid assets subsequent to investor redemptions, especially amid elevated macroeconomic uncertainty. Turning to individual securities, we find that when liquidating corporate bonds to meet redemptions, managers tend to follow a “liquidity pecking order,” selling relatively liquid corporate bonds first, which could mitigate immediate asset liquidation costs. The micro-level liquidity management practices of corporate bond funds have implications for financial stability of broad markets.