Holdings of illiquid assets by U.S. mutual funds have risen in the last decade, sparking concern that funds could be in trouble in the event of an economic downturn, a recent study from the Federal Reserve said.
The study, published last month, found that the 10 largest bank loan mutual funds have increased their holdings of the hardest-to-value, generally most illiquid assets over the past decade. Moreover, the average fraction of liquid assets — by the study's measure — to total assets held by bank loan mutual funds have held relatively stable over the same period. "This combination of rising hard-to-value, illiquid holdings amid generally stable liquid holdings might indicate rising liquidity risks," the study said.
One key concern is that large investor redemptions from mutual funds could lead the funds to sell assets at "fire sale" prices, which could negatively impact other financial markets.
Net assets in bank loan mutual funds stood at almost $112 billion, as of March, up from about $24 billion at year-end 2009. Similarly, net assets in high-yield mutual funds have increased to almost $250 billion in March from about $157 billion in December 2009, the study found.
Assessing the liquidity profile of mutual fund holdings is very difficult, largely due to the scarcity of comprehensive, high frequency market data and the lack of related disclosures by mutual funds.
Study authors — Kenechukwu Anadu, a senior financial markets specialist at the Federal Reserve Bank of Boston's risk and policy analysis unit, and Fang Cai, chief of financial stability assessment at the Federal Reserve Board — collected a "novel set of data" from publicly available Securities and Exchange Commission forms.
The research found that for bank loan mutual funds, the liquidity ratio appears relatively stable over the years, on average, although its range has narrowed since 2012, while the illiquidity ratio has trended up. For high-yield mutual funds, liquidity ratios have been relatively stable, on average, while average illiquidity ratios have narrowed in recent years.
The authors concluded by saying there's more work needed on the topic.
"While these indicators can serve as useful monitoring tools, more detailed data and more empirical work is needed to better understand the degree to which bank loan and high-yield corporate bond mutual funds' liquidity (and illiquidity) profiles have evolved over the years," the study said.