BIS Quarterly on Bond Fund Risks
The Bank for International Settlements' BIS Quarterly Review writes on "Open-ended bond funds: systemic risks and policy implications." The summary says, "The March 2020 market turmoil revived concerns about the amplification of financial stability risks by non-bank financial intermediaries, including open-ended bond funds ('bond OEFs'). A bond OEF pools capital to invest in fixed income instruments -- corporate and other bonds -- while typically granting its investors the right to redeem their shares for cash on a daily basis. Through this liquidity transformation, bond OEFs collectively can give rise to financial stability risks. During the early days of the Covid19 pandemic, bond OEFs experienced intensive but short-lived outflows amid a significant decline in market liquidity and high valuation uncertainty. Conditions remained tense until major central banks stepped in to backstop bond markets." It continues, "This episode has sparked a discussion about bond OEFs' resilience, the comprehensiveness of their liquidity management tools, especially in times of stress, and the tools' adequacy for financial stability more broadly. Advocates of the current industry setup point to the swift market recovery and the reversal of fund outflows that followed the turmoil of March 2020. Critics, pointing to previous, similar episodes, question bond OEFs' ability to withstand large shocks without public sector support and call for these funds' regulation to be revisited." The piece adds, "In this special feature, we analyse redemption dynamics and bond OEFs' response during the March 2020 turmoil, asking whether funds' existing liquidity management tools are conducive to financial stability. Our focus is on actively managed high-yield, investment grade and general bond OEFs. Given their liquidity transformation, these OEFs employ several tools to manage the risk of large redemptions, such as holding liquidity buffers or using swing pricing. We find, however, that bond OEFs' lines of defence did not prevent spillovers across funds and procyclical asset sales."
