Is The Rush To Safety Making Corporate Bonds Unsafe?

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Is The Rush To Safety Making Corporate Bonds Unsafe? by Knowledge@Wharton

Skittish investors seeking safety have poured a lot of money into corporate bond mutual funds in recent years. Which raises the question: What happens when that flow reverses?  

In their paper, “Investor Flows and Fragility in Corporate Bond Funds,” Wharton finance professor Itay Goldstein, and co-authors Hao Jiang of Michigan State and David Ng of Cornell, studied the flows in performance of those mutual funds to determine what impact heavy withdrawals can have on individual funds, the bond market, and the broader economy. In this interview with Knowledge@Wharton, Goldstein explains what they learned.

An edited transcript of the interview appears below.

A Question of Fragility:

Assets of mutual funds that invest in corporate bonds have grown substantially in recently years. Following the crisis, many investors felt that they did not have many attractive investment vehicles. And a lot of money has basically flown into mutual funds that invest in corporate bonds. Now this poses a very interesting challenge for researchers. For many years, there has been a lot of research studying mutual funds that invest in equities. But there hasn’t been that much research looking into mutual funds that invest in bonds, and in particular in corporate bonds.

Now there’s a growing concern of fragility — the possibility that a lot of this money is going to be withdrawn at the same time from many mutual funds, as a result effecting the prices of corporate bonds, and potentially destabilizing the market for them. And having also some real effects for the economy as a whole.

As a result there is, I think, growing importance to understand the patterns of flows and performance of mutual funds that invest in corporate bonds, and this is what we do in this study

The Opposite of Equity Mutual Funds:

Previous research on equity mutual funds basically showed that outflows are not very sensitive to bad performance. What we show in the context of corporate bond mutual funds is that outflows are much more sensitive to bad performance. In fact, outflows are more sensitive to bad performance than inflows are to good performance, which is the complete opposite of what people tend to find in the context of equity mutual funds.

See the full article here.

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