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ICIfundstability
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Yesterday’s Fed blog assumed that spillover effects existed after bond mutual fund outflows, and was based solely on a theoretical “calibrated” model. The authors failed to look at actual experience during the “Taper Tantrum”, or at the historical data that demonstrate the absence of such spillover effects. Today’s blog is even further divorced from reality. This blog appears to assume a 50 percent outflow across high-yield bond mutual funds, to get spillover effects that the authors admit are “relatively small and nonsystemic.” ICI recently published data on weekly high-yield bond mutual fund flows going back to 2010, enabling policymakers to get a sense of how large those flows were relative to assets. For more information, see https://www.ici.org/viewpoints/view_15_hybf_flows. Simply put, the assumption of 50 percent outflows across high-yield bond funds is not supported by historical data. In fact, it is very rare for weekly inflows or outflows to exceed 2 percent of assets in any given week; for all of 2015, cumulative outflows from high-yield bond mutual funds, excluding floating-rate funds, were well under 10 percent of assets. Looking at annual flow data back to 2000, the blog’s shock assumption is about five times larger than any actual annual outflow experienced by high-yield bond mutual funds in aggregate. This makes us curious about other assumptions embedded in the analysis. -Sean Collins and Chris Plantier, Investment Company Institute
This blog argues that when interest rates rise, bond mutual fund outflows create significant feedback effects, raising interest rates even more. The result, however, is based on a theoretical “calibrated” model. A better approach is to look at actual experience. Consider the “Taper Tantrum” of May-June 2013. Long-term interest rates rose by about 100 basis points, similar to the rate shock the theoretical model assumes. Rises in interest rates were tied closely to statements by Fed officials; outflows from bond mutual funds were quite modest; and evidence is lacking that even those modest outflows created further increases in interest rates. For more information, see Collins and Plantier (2014) at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2510666. Consider also what the logic of this model implies. The model would appear to apply to all market participants who buy and sell bonds, including the Federal Reserve itself. The Fed holds more than $4 trillion in bonds. According to this theoretical model, when the Fed begins to sell those bonds, long-term interest rates will spike. In reality, we doubt that gradual sales of bonds by the Fed will have much effect on bond prices, provided market participants expect and understand those sales. The same would be true of the modest outflows expected from bond mutual funds following a rise in interest rates. Sean Collins and Chris Plantier, Investment Company Institute
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Feb 18, 2016