DP19250 Intermediary Balance Sheet Constraints, Bond Mutual Funds’ Strategies, and Bond Returns
We show that after the introduction of the leverage ratio constraints on bank-affiliated dealers, bond mutual funds have engaged in more liquidity provision in investment-grade corporate bonds and that the performance of funds with liquidity-supplying strategies has benefited. Not only have regulations transferred profits associated with liquidity provision in the corporate bond market to mutual funds, but the liquidity and returns of investment-grade corporate bonds have become more exposed to redemptions from the bond mutual fund industry, suggesting that the regulations have made investment-grade corporate bonds more volatile. Accordingly, we observe that investment-grade corporate bonds that are more exposed to leverage ratio constraints experienced a more severe deterioration in liquidity and returns at the onset of the COVID-19 pandemic.
