Liquidity Transformation Risks in U.S. Bank Loan and High-Yield Mutual Funds

Abstract

Assessing liquidity transformation risks in MFs is difficult, largely due to a lack of detailed data on fund assets’ liquidity. In this note, we identify some indicators of funds’ liquidity profiles, and examine them in a sample of bank loan (BL, also referred to as “leveraged loans”) and high-yield corporate bond (HY) MFs, which invest in relatively illiquid and riskier assets and, thus, for which vulnerabilities associated with liquidity transformation are generally most salient. We find that the ten largest BL MFs 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 our measure) to total assets held by BL MFs 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. We also find that the ten largest HY MFs’ relative holdings of the hardest-to-value assets declined modestly in recent years, and liquid assets have held relatively stable, although the range has widened.