In times of heightened volatility, equity mutual funds rely on active management to maintain sufficient liquidity, according to new research from a member of York University’s Schulich School of Business.
In the paper, Aleksandra Rzeźnik, assistant professor of finance at Schulich, argues investor redemptions of these funds can cause the investment vehicle to rebalance its holdings.
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“I was interested in the role of mutual funds, the way they manage their portfolio, whether it has any externalities or [if] it has any spillover effects to the prices in the market.”
The report, which is designed to help policy makers understand financial fragility or instability, found mutual funds are vulnerable to extensive withdrawals from investors. If that withdrawal comes at a distressing time in the market, the investors will probably liquidate at a discount.
“A second person withdrawing the money [isn’t] going to get the full price, it’s going to get a discounted part of the portfolio. We have a red-light situation as we had with banks [where] everybody wants to withdraw first because if you are the last one withdrawing, you might be left with nothing.”
In response to investor withdrawals, which could potentially cause an event similar to a bank run, fund managers systematically prioritized liquidity preservation by selling off the least liquid assets in the investment vehicle.
The fund management decision, Rzeźnik notes, has a direct impact on for the market price of liquidity. This process can help explain why some public equities and specific sectors are more impacted during volatile times and financial crises, she adds.
She was influenced by her studies while working on her PhD in Copenhagen to investigate liquidity management by mutual funds. The work for this paper began in earnest back in 2013 and is now forthcoming in the journal Management Science. The report was informed by monthly holding data from these funds to measure the liquidity management.
Rzeźnik is currently working on seven new papers looking at a variety of financial events including how peer fragility affects mutual fund behaviour.