Multi-Sector Bond Funds in Emerging Markets—Easy Come, Easy Go

Global Financial Stability Notes, December 16, 2021

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Unconstrained multi-sector bond funds (MSBFs) can be a source of spillovers to emerging markets and potentially exert a sizable impact on cross-border flows.
MSBFs have grown their investment in emerging markets in recent years and are highly concentrated—both in their positions and their decision-making.
Theoretically, MSBFs’ size, multisector mandate, and unconstrained nature allows them to be a source of financial stability in periods of wide-spread market turmoil while others sell at fire-sale prices.
Empirical finding: building on Cortes and Sanfilippo (2020) and incorporating data around the COVID-19 crisis, the note finds that MSBFs could have contributed to increase market stress in selected emerging markets.

Opportunistic behavior: MSBFs typically exhibit opportunistic behavior much more so than other investment funds.
Concentrated rebalancing under stress: When faced with large investor redemptions during the COVID-19 crisis, the sample of MSBFs chose to rebalance portfolios in a concentrated manner.
Liquidity management outcome: MSBFs raised a large proportion of cash in a few specific local currency bond markets.

Amplification of stress: Concentrated rebalancing and cash-raising in a few local currency bond markets may have contributed to exacerbating the relative underperformance of these local currency bond markets to broader emerging market indices.
Cross-border flow implication: Because of their size and mandate, MSBFs have the potential to exert a sizable impact on cross-border flows into and out of emerging markets.

Monitor concentration: Authorities and market participants should monitor concentration in positions and decision-making within MSBFs given their potential to create localized market stress.
Assess liquidity and redemption dynamics: Understanding MSBFs’ liquidity management choices under stress—particularly concentrated rebalancing—can inform macroprudential and market-stability responses.
Consider cross-border spillovers: Policy frameworks should account for the possibility that global, unconstrained funds can transmit shocks across markets through concentrated portfolio adjustments.

Multi-Sector Bond Funds in Emerging Markets--Easy Come, Easy Go
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