Can Mutual Funds Harvest Corporate Bond Liquidity Premia?

50 Pages Posted: 17 Feb 2024

Date Written: February 1, 2024

Abstract

This paper studies how the performance of corporate bond mutual funds varies with the liquidity of their bond holdings. I show that funds holding relatively illiquid corporate bonds on average underperform funds that hold more liquid portfolios on a risk-adjusted basis over the period 2010-2022. The relation between portfolio liquidity and fund performance is strongest within the set of high-yield funds, consistent with these funds' large exposure to redemption risk. Moreover, the underperformance of less liquid funds is driven by periods in which market liquidity drops, i.e., when flow-induced asset sales are most costly. My findings suggest a reduced ability of mutual funds to harvest illiquidity premia in corporate bonds, which might be caused by a structural liquidity mismatch arising from open-ended structures.

Keywords: Mutual funds, corporate bonds, liquidity, performance

JEL Classification: G10, G11, G23

Suggested Citation

Dekker, Lennart, Can Mutual Funds Harvest Corporate Bond Liquidity Premia? (February 1, 2024). Available at SSRN: https://ssrn.com/abstract=4716745 or http://dx.doi.org/10.2139/ssrn.4716745

Lennart Dekker (Contact Author)

De Nederlandsche Bank ( email )

Netherlands

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