Dynamic Liquidity Management by Corporate Bond Mutual Funds

How do corporate bond mutual funds manage liquidity to meet investor redemptions? We show that during tranquil market conditions, these funds tend to reduce liquid asset holdings to meet redemptions, temporarily increasing relative exposures to illiquid asset classes. When aggregate uncertainty rises, however, they tend to scale down their liquid and illiquid assets proportionally to preserve portfolio liquidity. This fund-level dynamic management of liquidity appears to affect the broad financial market: Redemptions from the corporate bond fund sector lead to more corporate bond selling during high-uncertainty periods, which generates price pressures and predicts strong return reversals.