Financial Fragility in Open-ended Mutual Funds: The Role of Liquidity Management Tools

Abstract

We study the role of liquidity management tools (LMTs) in mitigating financial fragility in investment funds during the COVID-19 market distress. We employ a unique dataset that reports the availability of different types of LMTs in a sample of Irishdomiciled corporate bond funds. We find that funds employing price-based tools such as redemption fees or anti-dilution levies experienced lower net outflows in March 2020, as compared to funds only employing quantity-based tools such as redemption gates, temporary suspensions or redemption in kind. This difference is stronger among funds with a high sensitivity of flows to past-performance and reflects both higher gross inflows and lower gross outflows during this episode. Funds with price-based LMTs also rebalance their portfolios towards less liquid bonds, which results in lower price fragility among bonds held disproportionally by our sample of Irish-domiciled funds.

Keywords: liquidity management tools, investment funds, COVID-19, financial fragility

JEL Classification: G2, G23