Boston Fed Staff Assesses Liquidity Risk in Bank Loan and High-Yield Funds

A recent note by Kenechukwu Anadu of the Federal Reserve Bank of Boston and Fang Cai of the Fed Board of Governors examined certain indicators of mutual funds’ liquidity-risk profiles and a sample of bank loan and high-yield corporate bond mutual funds. Based on their observations, the authors conclude that: (1) a combination of rising hard-to-value, illiquid holdings in bank loan funds amid generally stable liquid holdings might indicate rising liquidity risks and (2) for high-yield funds, the average levels of liquid assets have increased, while illiquid assets have declined over the years. The authors write that investors’ interest in floating-rate instruments have contributed to increased net assets in bank loan mutual funds. According to their data:

• As of March 2019, net assets in bank loan funds were $112 billion, up from about $24 billion at year-end 2009. Of that total, about $91 billion were invested in loans, up from less than $5 billion in 2008.
• Net assets in high-yield mutual funds increased from about $157 billion in December 2009 to almost $250 billion in March 2019.

They note that during recent market volatility in December 2018, bank loan funds experienced record net outflows of $13 billion, or almost 10 percent of net assets, and high-yield funds experienced net outflows of $6 billion or almost 3 percent of net assets, although both fund types functioned well during the period. The authors cautioned, however, that the short duration of the volatility event and a strong economy may have cushioned losses. They acknowledge a “scarcity of comprehensive, high frequency market data and the lack of related disclosures” by mutual funds and write that it is too early to assess how the SEC’s liquidity risk management rule would affect liquidity transformation risks among mutual funds and ETFs. They also examined the credit profiles of bank loan and high-yield corporate bond funds and observed no extreme outliers in terms of liquidity risk.