## 1. Financial Transactions in US Treasury Securities

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---

### Overview
- In March 2020 most fund sectors faced large outflows; MMFs faced inflows as investors switched from prime MMFs to safer MMFs.
- Funds’ liquidity profiles deteriorated in March 2020 together with overall market liquidity.
- With unprecedented central bank policy support, daily flows returned to their pre–COVID-19 levels in less than a month, and there have not been any widespread fund closures so far.
- The episode rekindled debate on financial stability risks from a larger asset management sector and the vulnerability of funds holding relatively illiquid assets while offering near-daily redemptions.

### Funds’ portfolio composition and reaction to redemption shocks
- Most fixed-income funds used a mix of strategies to meet outflows; few funds suspended redemptions.
- Funds facing outflows:
  - Used liquidity buffers and shed liquid assets such as cash and cash equivalents to cover redemptions.
  - Saw the proportion of less liquid assets (corporate bonds, and to a lesser extent sovereign bonds) in portfolios increase as liquid buffers were depleted.
  - Nevertheless, average rating quality profiles saw marginal improvements in April 2020, indicating asset managers largely avoided short-term deterioration in risk profiles.
- Funds receiving inflows tended to hoard cash and delay investment amid uncertain market conditions.
- Cash equivalents include securities and time deposits with maturities of less than 92 days.
- Evidence indicates US Treasury securities and ETF shares served as alternative sources of financing redemptions for some funds.

### Quantile-regression evidence on liquidation behavior
- In normal times, high-outflow funds tend to cover redemptions with cash, cash equivalents, and sovereign bonds while holding onto corporate exposures.
- Corporate bond positions are negatively correlated with fund net flows at distribution tails (outflows accompanied by increases in corporate bond holdings).
- During the COVID-19 period (starting February 2020) for lower-flow deciles:
  - Sensitivities increased for cash and cash equivalents in some cases.
  - Sensitivities more than doubled for sovereign bonds.
  - Sensitivities substantially decreased for corporate bonds.
- Overall behavior consistent with a “waterfall” liquidation approach: sell most liquid assets first, then riskier or less liquid assets as needed.

### Funds’ liquidity conditions and selling pressure
- During the COVID-19 stress episode portfolio liquidity declined for all funds, with the most severe deterioration for funds facing strong outflows.
- Bid-ask spreads (value-weighted) and portfolio liquidity:
  - Funds with liquid portfolios were better able to attract inflows.
  - Funds facing large outflows sold liquid assets and bought illiquid assets, worsening remaining portfolio liquidity.
  - Funds facing modest outflows or inflows generally bought and sold assets with similar bid-ask spreads.
- Trading behavior (bid-ask spread of assets bought vs. sold relative to fund portfolio average):
  - For funds facing outflows, the liquidity differential between assets sold and assets bought increased in Q1 2020.
  - Some funds’ willingness to absorb illiquid assets under uncertainty helped marginally mitigate price pressures but worsened portfolio liquidity.
- Selling pressure and price impacts:
  - In March 2020 the bid-ask spreads of assets most heavily sold across fixed-income funds facing large redemptions increased more than those of assets not under selling pressure.
  - Cumulative returns of assets under selling pressure declined more than those of assets not facing selling pressure.
  - Funds’ sales of liquid assets likely contributed to price pressures and liquidity strains in core fixed-income markets, including US Treasury markets, and sales of corporate bonds may have amplified price dislocations in risky credit markets.

### Empirical coverage and sample notes (selected exact figures)
- Sample coverage and data windows:
  - Panels and samples include monthly data for fixed-income funds with assets over $0.5 billion from January 2015 to April 2020 (or to May 2020 where specified).
  - Panel/sample specifics: at end-June 2020 the figure covers 45 percent of equity funds, 43 percent of fixed-income funds, 30 percent of mixed funds, and 78 percent of money market funds reported by the International Investment Fund Association for the global fund sector (including funds of funds).
  - Detailed portfolio holdings data available for a subset: 638 funds representing about 24 percent of the global fixed-income sector.
  - Panels 1 and 2 in Figure 5 are based on detailed holdings of 390 fixed-income funds holding approximately 13,000 identifiable securities in March 2020.
- Fund suspensions and AUM:
  - In the first half of 2020, mutual funds suspended withdrawals from funds with a total of $62 billion in assets under management, 0.11 percent of the sector’s total assets.
- Model/sample periods and regressions:
  - Quantile regressions use monthly data for fixed-income funds with assets over $0.5 billion from January 2015 to May 2020.
  - Daily regression of net flows on returns covers January 2019–May 2020.

### Determinants of investor flows and flow-performance relationship
- Funds offering near-daily redemptions but holding relatively illiquid assets are inherently fragile due to redistribution of trading costs and strategic complementarities that can amplify outflows.
- During COVID-19, sensitivities of flows to contemporaneous returns increased substantially for funds with very high outflows:
  - For the bottom decile of net flows the sensitivity increased from 0.06 percent to 0.54 percent for each 1 percent increase in returns.
- Daily-flow evidence:
  - The sensitivity of flows for funds facing low returns more than doubled during the COVID-19 pandemic to 0.86 percent for each 1 percent increase in returns.
- Interpretation:
  - Investors became more likely to redeem shares when perceiving mounting valuation risk, intensifying feedback from security devaluations to capital withdrawals and increasing the risk of runs if liquidity conditions had deteriorated further.

### Key implications
- The “waterfall” approach (selling most liquid assets first) mitigates immediate realized losses but leaves remaining investors with less liquid portfolios and can propagate liquidity strains.
- Large outflows forced some funds to sell riskier assets, contributing to price dislocations in both core and risky credit markets.
- Enhanced sensitivity of flows to poor performance during stress episodes suggests stronger feedback loops between asset price declines and redemption pressures, increasing systemic vulnerability in stressed market conditions.

*Source: anea2020002 - 1. Financial Transactions in US Treasury Securities (IMF Monetary and Capital Markets).*

### CONCLUSIONS

### Asset growth and structural fragilities
- Assets under management by investment funds have grown rapidly since the global financial crisis (FSB 2020).
- Funds can be subject to fragilities because of the mismatch between the liquidity of funds’ underlying assets and end investors’ ability to redeem on a near-daily basis.
- Second-round effects can occur when redemptions cause selling pressure that then reinforces price declines and leads to further redemptions.
- Policymakers have called for implementation of liquidity and redemption management tools, such as swing pricing, redemption fees, and other anti-dilution methods (FSB 2017; IOSCO 2018), which until recently had been largely untested in a market-wide stress scenario.

### The March 2020 stress episode: market reaction and implications
- The decline in prices across various asset classes and subsequent large portfolio losses and significant outflows observed in March 2020 presented an unparalleled stress test for the fund industry.
- Central banks reacted with unprecedented speed and implemented wide-ranging policy measures to preserve market functioning and maintain the flow of credit to the economy. Measures included lending against risky assets, including commercial paper, mortgage-backed securities, corporate bonds, and exchange-traded fund shares, and offering credit to primary dealers and money market funds.
- Supported by rebounding asset prices and improved investor confidence, fund flow patterns normalized relatively quickly.
- Even though the stress episode in March 2020 was relatively short-lived, important weaknesses were highlighted:
  - Most funds sold relatively liquid assets first, which could have deepened redemption stress absent massive central bank interventions.
  - There was some evidence of price declines in markets following selling pressure, highlighting the risk of fire sales if funds must unload relatively illiquid assets quickly.
  - Fund investors appeared to respond to flow-performance risks by reducing holdings in underperforming funds already exposed to high redemption pressure.

### Empirical insights and robustness
- Results are drawn from piecewise linear regressions of daily fund net flows on past returns, allowing flow-performance sensitivities to vary across performance levels.
- Running several robustness tests, including an alternative stress dummy based on values of the VIX exceeding or equal to its 95th percentile during January 2010 to May 2020, and adding additional variables such as lagged flows and lagged returns (the latter together with interaction terms for the respective dummy used) did not change results qualitatively.
- In the long run, markets may start to anticipate future central bank interventions in times of stress, which could lead to moral hazard.

### Policy recommendations and forward-looking measures
- A comprehensive review of available prudential tools in the investment fund sector is warranted.
- Tools to better manage redemptions could include:
  - enhanced use of minimal requirements for liquidity buffers;
  - more widespread adoption of swing pricing;
  - if swing pricing is not possible, requiring funds to better match redemption periods to the liquidity profiles of their portfolios.
- Such measures could help mitigate vulnerabilities revealed during the COVID-19 market turmoil (FSB 2020; IMF 2019).

### Key sample statistics (from Appendix Table 1)
- Sample period (daily fund net flow and return data): Jan. 1, 2019–May 1, 2020.
- Sample period (fund net flow, return and portfolio data monthly): January 2015–May 2020.
- Sample period (detailed portfolio data monthly): April 2019–March 2020.
- Number of funds: 2,073 (daily), 2,877 (monthly), 638 (detailed monthly).
- Fund domicile shares (daily; monthly; detailed monthly):
  - United States: 34% ; 29% ; 43%
  - Luxembourg: 27% ; 21% ; 30%
  - Ireland: 9% ; 8% ; 6%
  - Other: 30% ; 42% ; 21%
- NAV (bn USD, mean): 2.3 ; 2.5 ; 3.8
- NAV (bn USD, median): 1.1 ; 1.1 ; 2.1
- Of global fixed income sector (IIFA, March 2020): 25.33% ; 64.52% ; 22.47%
- Flow net (mean): 0.0487% ; 1% ; 0.92%
- Flow net (median): 0.0015% ; 0.22% ; 0.44%
- Return (median): 0.0096% ; 0.21% ; 0.25%
- Return (mean): 0.003% ; 0.14% ; –0.02%

*Source: anea2020002 - CONCLUSIONS*

### 1. Financial Transactions in US Treasury Securities

### 1. Financial Transactions in US Treasury Securities

### Overview
- In March 2020 most fund sectors faced large outflows; MMFs faced inflows as investors switched from prime MMFs to safer MMFs.
- Funds’ liquidity profiles deteriorated in March 2020 together with overall market liquidity.
- With unprecedented central bank policy support, daily flows returned to their pre–COVID-19 levels in less than a month, and there have not been any widespread fund closures so far.
- The episode rekindled debate on financial stability risks from a larger asset management sector and the vulnerability of funds holding relatively illiquid assets while offering near-daily redemptions.

### Funds’ portfolio composition and reaction to redemption shocks
- Most fixed-income funds used a mix of strategies to meet outflows; few funds suspended redemptions.
- Funds facing outflows:
  - Used liquidity buffers and shed liquid assets such as cash and cash equivalents to cover redemptions.
  - Saw the proportion of less liquid assets (corporate bonds, and to a lesser extent sovereign bonds) in portfolios increase as liquid buffers were depleted.
  - Nevertheless, average rating quality profiles saw marginal improvements in April 2020, indicating asset managers largely avoided short-term deterioration in risk profiles.
- Funds receiving inflows tended to hoard cash and delay investment amid uncertain market conditions.
- Cash equivalents include securities and time deposits with maturities of less than 92 days.
- Evidence indicates US Treasury securities and ETF shares served as alternative sources of financing redemptions for some funds.

### Quantile-regression evidence on liquidation behavior
- In normal times, high-outflow funds tend to cover redemptions with cash, cash equivalents, and sovereign bonds while holding onto corporate exposures.
- Corporate bond positions are negatively correlated with fund net flows at distribution tails (outflows accompanied by increases in corporate bond holdings).
- During the COVID-19 period (starting February 2020) for lower-flow deciles:
  - Sensitivities increased for cash and cash equivalents in some cases.
  - Sensitivities more than doubled for sovereign bonds.
  - Sensitivities substantially decreased for corporate bonds.
- Overall behavior consistent with a “waterfall” liquidation approach: sell most liquid assets first, then riskier or less liquid assets as needed.

### Funds’ liquidity conditions and selling pressure
- During the COVID-19 stress episode portfolio liquidity declined for all funds, with the most severe deterioration for funds facing strong outflows.
- Bid-ask spreads (value-weighted) and portfolio liquidity:
  - Funds with liquid portfolios were better able to attract inflows.
  - Funds facing large outflows sold liquid assets and bought illiquid assets, worsening remaining portfolio liquidity.
  - Funds facing modest outflows or inflows generally bought and sold assets with similar bid-ask spreads.
- Trading behavior (bid-ask spread of assets bought vs. sold relative to fund portfolio average):
  - For funds facing outflows, the liquidity differential between assets sold and assets bought increased in Q1 2020.
  - Some funds’ willingness to absorb illiquid assets under uncertainty helped marginally mitigate price pressures but worsened portfolio liquidity.
- Selling pressure and price impacts:
  - In March 2020 the bid-ask spreads of assets most heavily sold across fixed-income funds facing large redemptions increased more than those of assets not under selling pressure.
  - Cumulative returns of assets under selling pressure declined more than those of assets not facing selling pressure.
  - Funds’ sales of liquid assets likely contributed to price pressures and liquidity strains in core fixed-income markets, including US Treasury markets, and sales of corporate bonds may have amplified price dislocations in risky credit markets.

### Empirical coverage and sample notes (selected exact figures)
- Sample coverage and data windows:
  - Panels and samples include monthly data for fixed-income funds with assets over $0.5 billion from January 2015 to April 2020 (or to May 2020 where specified).
  - Panel/sample specifics: at end-June 2020 the figure covers 45 percent of equity funds, 43 percent of fixed-income funds, 30 percent of mixed funds, and 78 percent of money market funds reported by the International Investment Fund Association for the global fund sector (including funds of funds).
  - Detailed portfolio holdings data available for a subset: 638 funds representing about 24 percent of the global fixed-income sector.
  - Panels 1 and 2 in Figure 5 are based on detailed holdings of 390 fixed-income funds holding approximately 13,000 identifiable securities in March 2020.
- Fund suspensions and AUM:
  - In the first half of 2020, mutual funds suspended withdrawals from funds with a total of $62 billion in assets under management, 0.11 percent of the sector’s total assets.
- Model/sample periods and regressions:
  - Quantile regressions use monthly data for fixed-income funds with assets over $0.5 billion from January 2015 to May 2020.
  - Daily regression of net flows on returns covers January 2019–May 2020.

### Determinants of investor flows and flow-performance relationship
- Funds offering near-daily redemptions but holding relatively illiquid assets are inherently fragile due to redistribution of trading costs and strategic complementarities that can amplify outflows.
- During COVID-19, sensitivities of flows to contemporaneous returns increased substantially for funds with very high outflows:
  - For the bottom decile of net flows the sensitivity increased from 0.06 percent to 0.54 percent for each 1 percent increase in returns.
- Daily-flow evidence:
  - The sensitivity of flows for funds facing low returns more than doubled during the COVID-19 pandemic to 0.86 percent for each 1 percent increase in returns.
- Interpretation:
  - Investors became more likely to redeem shares when perceiving mounting valuation risk, intensifying feedback from security devaluations to capital withdrawals and increasing the risk of runs if liquidity conditions had deteriorated further.

### Key implications
- The “waterfall” approach (selling most liquid assets first) mitigates immediate realized losses but leaves remaining investors with less liquid portfolios and can propagate liquidity strains.
- Large outflows forced some funds to sell riskier assets, contributing to price dislocations in both core and risky credit markets.
- Enhanced sensitivity of flows to poor performance during stress episodes suggests stronger feedback loops between asset price declines and redemption pressures, increasing systemic vulnerability in stressed market conditions.

*Source: anea2020002 - 1. Financial Transactions in US Treasury Securities (IMF Monetary and Capital Markets).*

### CONCLUSIONS

### CONCLUSIONS

### Asset growth and structural fragilities
- Assets under management by investment funds have grown rapidly since the global financial crisis (FSB 2020).
- Funds can be subject to fragilities because of the mismatch between the liquidity of funds’ underlying assets and end investors’ ability to redeem on a near-daily basis.
- Second-round effects can occur when redemptions cause selling pressure that then reinforces price declines and leads to further redemptions.
- Policymakers have called for implementation of liquidity and redemption management tools, such as swing pricing, redemption fees, and other anti-dilution methods (FSB 2017; IOSCO 2018), which until recently had been largely untested in a market-wide stress scenario.

### The March 2020 stress episode: market reaction and implications
- The decline in prices across various asset classes and subsequent large portfolio losses and significant outflows observed in March 2020 presented an unparalleled stress test for the fund industry.
- Central banks reacted with unprecedented speed and implemented wide-ranging policy measures to preserve market functioning and maintain the flow of credit to the economy. Measures included lending against risky assets, including commercial paper, mortgage-backed securities, corporate bonds, and exchange-traded fund shares, and offering credit to primary dealers and money market funds.
- Supported by rebounding asset prices and improved investor confidence, fund flow patterns normalized relatively quickly.
- Even though the stress episode in March 2020 was relatively short-lived, important weaknesses were highlighted:
  - Most funds sold relatively liquid assets first, which could have deepened redemption stress absent massive central bank interventions.
  - There was some evidence of price declines in markets following selling pressure, highlighting the risk of fire sales if funds must unload relatively illiquid assets quickly.
  - Fund investors appeared to respond to flow-performance risks by reducing holdings in underperforming funds already exposed to high redemption pressure.

### Empirical insights and robustness
- Results are drawn from piecewise linear regressions of daily fund net flows on past returns, allowing flow-performance sensitivities to vary across performance levels.
- Running several robustness tests, including an alternative stress dummy based on values of the VIX exceeding or equal to its 95th percentile during January 2010 to May 2020, and adding additional variables such as lagged flows and lagged returns (the latter together with interaction terms for the respective dummy used) did not change results qualitatively.
- In the long run, markets may start to anticipate future central bank interventions in times of stress, which could lead to moral hazard.

### Policy recommendations and forward-looking measures
- A comprehensive review of available prudential tools in the investment fund sector is warranted.
- Tools to better manage redemptions could include:
  - enhanced use of minimal requirements for liquidity buffers;
  - more widespread adoption of swing pricing;
  - if swing pricing is not possible, requiring funds to better match redemption periods to the liquidity profiles of their portfolios.
- Such measures could help mitigate vulnerabilities revealed during the COVID-19 market turmoil (FSB 2020; IMF 2019).

### Key sample statistics (from Appendix Table 1)
- Sample period (daily fund net flow and return data): Jan. 1, 2019–May 1, 2020.
- Sample period (fund net flow, return and portfolio data monthly): January 2015–May 2020.
- Sample period (detailed portfolio data monthly): April 2019–March 2020.
- Number of funds: 2,073 (daily), 2,877 (monthly), 638 (detailed monthly).
- Fund domicile shares (daily; monthly; detailed monthly):
  - United States: 34% ; 29% ; 43%
  - Luxembourg: 27% ; 21% ; 30%
  - Ireland: 9% ; 8% ; 6%
  - Other: 30% ; 42% ; 21%
- NAV (bn USD, mean): 2.3 ; 2.5 ; 3.8
- NAV (bn USD, median): 1.1 ; 1.1 ; 2.1
- Of global fixed income sector (IIFA, March 2020): 25.33% ; 64.52% ; 22.47%
- Flow net (mean): 0.0487% ; 1% ; 0.92%
- Flow net (median): 0.0015% ; 0.22% ; 0.44%
- Return (median): 0.0096% ; 0.21% ; 0.25%
- Return (mean): 0.003% ; 0.14% ; –0.02%

*Source: anea2020002 - CONCLUSIONS*

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_Source: https://www.imf.org/-/media/files/publications/gfs-notes/2020/english/anea2020002.pdf_