Dilution and Strategic Complementarity in Fixed-Income Funds: Evidence from European UCITS

Abstract

Concerns about dilution in fixed-income mutual funds have sparked regulatory proposals to mitigate dilution, yet empirical evidence remains sparse. Prior research on US bond funds indicates minimal dilution, with no clear link to systemic risks. Using data from 2018 to 2022, we estimate daily dilution for European UCITS fixed-income funds and find it negligible, both in absolute terms and relative to investment risk. Extending the model of Chen, Goldstein, and Jian (2010), we show theoretically that value differentials—the difference between a fund's ''intrinsic value'' and its NAV—could influence strategic trading by investors. However, we find no empirical evidence to support this concern, even during periods of market stress. Moreover, the absence of swing pricing does not appear to trigger increased strategic redemptions when value differentials are negative. These findings further reinforce the conclusion that dilution is minimal and does not pose significant risks to investors or financial stability.

Keywords: UCITS fixed-income mutual funds, Dilution, Investor Protection, Systemic Risk, Swing pricing

JEL Classification: G11, G14, G23