Mutual Fund Liquidity Transformation and Reverse Flight to Liquidity

We identify fixed-income mutual funds as an important contributor to the unusually high selling pressure in traditionally liquid asset markets during the Covid-19 crisis. We show that mutual fund liquidity transformation leads to pronounced investor outflows. In meeting redemptions, funds followed a pecking order by first selling their more liquid assets, which generated the most concentrated selling pressure in traditionally more liquid asset markets. Investors' flight to liquidity was thereby turned into an aggregate reverse flight to liquidity. The Fed's announced purchase of illiquid securities may be an effective policy tool for stabilizing liquidity transformation and liquid asset markets.